Fund managers: This is not private equity

At the height of the private equity fundraising boom, private equity GPs were never in a stronger position to negotiate hard on fee and carry terms. With some fund managers seeking to test whether the old 2&20 formula was set in stone or whether something even more favourable might pass muster, it was clear that private equity fund management was a lucrative game to be playing.

 

And that’s why some of the new breed of infrastructure GPs promoted with enthusiasm the idea that infrastructure investing was really just a form of private equity investing: essentially the same approach, and essentially, therefore, the same fee and carry structure applicable.

In retrospect it may seem surprising that anyone was brave enough to make this claim given the fairly obvious point that private equity and infrastructure have intrinsically different risk/return profiles. This was, however, the era of cheap debt – a point not lost on Mike Powell, head of alternatives at UK pension USS. He says: “Too much leverage was used to try and get the return up to a level where the incentives were justified – and it didn’t work.”

Far from all infrastructure funds deserve to be tarred with the same brush. In the same way that only a handful of private equity funds have dared to push beyond 2&20, only a handful of infrastructure fund managers dared get that high. Management fees for infrastructure funds are typically 1.5 percent and this, according to an LP survey conducted by InfrastructureInvestor last year, is very much in accordance with what investors find acceptable.

There has also been some discussion about whether the long-term nature of infrastructure projects brings into question the suitability of 10- or 12-year time horizons for funds. At a recent media breakfast, Antin Infrastructure Partners’ chief executive Alain Rauscher insisted: “Ten years from now, we [the managers] have a good idea where we’ll be. We have no idea about 20 or 25 years’ time. There’s an issue of accountability.”       

Maybe so, but the debate will continue until both LPs and GPs can be absolutely sure that they have alighted on the right model for both parties. Whatever it is, it won’t be exactly the same as the private equity one.   

Case study: Kohlberg Kravis Roberts – think of 2&20 and halve it

Legendary New York investment firm Kohlberg Kravis Roberts (KKR) generated plenty of coverage when it announced it was launching a $4 billion-target debut infrastructure fund (it is understood the target has since been revised to $2.5 billion). It was then the focus of further attention when it revealed in February last year that the fund would charge investors a modest 1 percent management fee and 10 percent carried interest.

The move came as the 2&20 fee structure typically charged by private equity firms was coming under greater scrutiny – and also as questions were raised over whether infrastructure funds were justified in aspiring to the same fee-charging model.

KKR’s decision was groundbreaking, but also pragmatic in light of a tough post-crisis fundraising market. At the time, many LPs were expressing growing frustration at the pricing mechanisms being proposed to them by GPs and warned that, in the current market, they have more leverage in fee negotiations.   

The KKR revelation followed an announcement by fellow investment giant TPG that it would allow LPs to reduce commitments by as much as ten percent and cut its management fees by one-tenth regardless of whether LPs cut commitments.