It's all about fees

Perhaps the most misleading notion to emerge from the recent wave of what are loosely known as ‘developer funds’ is the idea that these vehicles, especially those that form a direct connection between a developer and a limited partner (LP), are just structures that enable institutional investors to invest directly in infrastructure projects.

In many ways, this misunderstanding has been fuelled by LPs themselves: commenting on its two partnerships with developers Lend Lease and BAM PPP, Henk Huizing, the head of infrastructure at Dutch pension PGGM, has repeatedly framed the joint ventures as part of PGGM’s strategy of “investing directly in infrastructure projects”.

If by “investing directly” Huizing means PGGM will now fully own these assets, instead of owning them through a shareholding in a third-party fund, then we are inclined to agree with him. But if by direct investment it should be read that PGGM will, all of a sudden, start running hospitals, schools and toll roads on a day-to-day basis, then the answer is clearly no.

In fact, it will be the developers PGGM has partnered with that will provide these asset management services, crucial to making sure the government revenues backing these assets will not dip. This distinction is important because it eliminates the idea that, somehow, developers, unlike general partners (GPs), do not provide asset management services as part of these funds.

Comparing the John Laing Infrastructure Fund (JLIF) – a developer fund – with HICL – a third-party fund formerly advised by a unit of UK bank HSBC – is a case in point. Both are listed funds focusing on public-private partnership (PPP) projects, especially UK PPPs; both offer asset management services; and both source their deals from the secondary market. But when it comes to the fees they charge, there are important differences.

HICL said in its annual results for 2010 that it paid £8.1 million (€9.3 million; $13.2 million) in fees to its investment adviser, InfraRed Capital Partners, which translates into a 1.1 percent annual management fee (1.5 percent for assets under construction), a 1 percent transaction fee, and £100,000 in advisory fees on a portfolio valued at £673.1 million as at March 31, 2011.

JLIF, on the other hand, paid its investment adviser £249,000 for the year ending December 31 2010 (this modest figure equates to one month of fees, since the fund listed in late November), amounting to a 1.1 percent base fee on a portfolio of some £270 million and a 0.75 percent transaction fee for assets that are not purchased from developer John Laing.

This last part is crucial because JLIF will likely source the vast majority of its assets from John Laing, which means the fund will, in effect, pay transaction fees of close to zero. But its annual base fee also gets more competitive as the fund’s portfolio grows, decreasing to 1 percent on the portion of the portfolio valued between €500 million and €1 billion and 0.9 percent on the part of the portfolio that climbs over €1 billion.

Detailed information is harder to find for unlisted vehicles like PGGM and Lend Lease’s UK  infrastructure fund, but an inside source at Lend Lease recently joked to us that no one in the organisation would be retiring to the Caribbean on the fees/carry generated from its partnership with PGGM.

While the source declined to talk numbers, we can at least infer that this vehicle, pointed out by Huizing as an example of a direct investment, actually carries some sort of fees attached. This is important because once we start viewing developer funds as investment vehicles that charge fees for the services they offer, the differences between a developer fund and a GP-operated vehicle become much more qualitative.

No frills

A few months ago, a well-known fund manager expressed confidence in the superiority of traditional funds. “It’s the same reason people prefer German cars: they are just better built,” he quipped. But perhaps there’s another transport analogy that better illustrates the competitive threat of developer funds: they are like low-cost airlines.

Like low cost-airlines, they basically offer many of the same services your standard airline offers, but in a no-frills, cheaper fashion. And like low-cost airlines, they have the potential to capture a whole segment of the market that was waiting for prices to come down before taking to the skies.