Is there such a thing as ‘core’ infrastructure?

Alinda Capital Partners is one of the heavyweights of the infrastructure asset class, as demonstrated by the firm’s repeat showing in our 2010 and 2011 rankings of the 30 largest infrastructure investors. Which is why, when the Connecticut-based fund manager decided to launch a new $3 billion “core” infrastructure fund on top of its two existing $3 billion and $4.1 billion funds, it got the infrastructure community buzzing.

The move marks the clearest statement by a major infrastructure fund manager that infrastructure is, and ought to be delineated as, an asset class with two basic strategies. On the one hand, there are the “core” assets, which don’t present much opportunity for operational, managerial and other improvements and will therefore exhibit fairly steady, predictable cash flows over the life of the investment. And, on the other, there are the so-called “value-added” investments, where such opportunity does exist: operations can be maximised or expanded, management can be improved and those steady and predictable cash flows can actually tick up and outperform core counterparts.

Dichotomy

Speaking at the Infrastructure Investor: Berlin forum in March, Thomas Putter, former chief executive of Allianz Capital Partners, put the dichotomy as such: you can either seek to buy infrastructure businesses and drive higher returns through operational improvements; or you can invest in infrastructure assets that provide yield safely and consistently. By labeling its first two funds as value-added and then carving out a new “core” platform, Alinda ostensibly endorsed a similar world view.

But there is a strong dissenting view, which starts from a familiar premise. Infrastructure comprises assets which support the daily functioning of the economy, but that essential nature doesn’t come with a free pass from making serious operational and capital improvements. Some say that, no matter what the infrastructure asset, one must still focus on adding value to it.

Take regulated utilities, such as water providers. These are often singled out as “core” infrastructure in consultants’ reports and presentations. Yet history shows that they often require substantial operational and managerial expertise to make the numbers work. For example, when investors scooped up a bunch of UK water utilities in the second part of the last decade, they often committed to long lists of capital expenditure requirements that would in due course be reflected in the regulatory return they could earn on their capital. Macquarie’s £8 billion (€9 billion; $13 billion) Thames Water acquisition alone carries a £5 billion capital spending plan over the next five years, which is expected to result in a 29 percent increase in the utility’s regulated asset base (RAB), according to ratings agency Moody’s.

This is why investors have not been afraid to bid above RAB for UK water providers: they know they can bring down the premium over time by making accretive additional investments to improve and expand operations.

Perhaps it is not surprising, then, that one reaction to the news of Alinda’s core fund seems to be the question of whether there really is such a thing as “core” infrastructure. Fund managers I spoke with also wonder whether Alinda chief Chris Beale will be able to draw a sharp enough distinction between the firm’s “core” and “value added” strategies to hit the $3 billion target on his new venture.

If Beale hits that $3 billion mark, the argument may be settled. If he falls short, then maybe opponents of the “core” vs. “value added” distinction were right after all.