Reaching for the lifebelt

Infrastructure won’t lay claim to being the most exciting area of investment in the world. But, in a world characterised by a surfeit of unsettling excitement and little in the way of reassuring predictability, it’s precisely the reason why investors should be clamoring to add more of it to their portfolios. Infrastructure is, in essence, something of a safe haven from global volatility.

Or, at least, parts of the infrastructure investment spectrum offer relative safety against an alarming backdrop of rollercoaster stock markets and dizzying fiscal deficits. Think core infrastructure in developed markets and you will not be far off the mark in seeking to establish where investor priorities lie at the current time.

Boe Pahari, head of infrastructure for Europe at Australian fund manager AMP Capital Investors, claims that the European fund currently being raised by his firm represents “the opportunity for moderate return with low risk” that comes through investing in assets that are relatively predictable for various reasons. These may include: monopolistic positions, a strong regulatory framework, availability payment mechanisms, insulation from GDP and alignment with inflation.

Regulated utilities are one example of assets which “remain attractive through periods of uncertainty” according to Pahari. Moreover, infrastructure funds keen to invest in such assets are finding a steady flow of investment opportunities. In Germany, for example, the decision of the government to phase out nuclear power in the wake of the Fukushima meltdown in Japan has dealt a heavy blow to the finances of some of the country’s utilities, forcing them to both deepen and accelerate divestment programmes that were already in place. 

Marcus Ayre, head of infrastructure transactions Europe at First State Investments in London, points out that because regulated utilities have a limited linkage to GDP, they are “less volatile and therefore relatively easier assets to price”. With those infrastructure assets that have a stronger linkage to economic performance, he maintains that pricing is the “real issue” because “many vendors have not yet got their heads round the idea of slow growth for a sustained period”.

From the limited partner (LP) perspective, a bias to regulated assets is a position that may have been reached independently of continuing economic turmoil. After all, many investors are still nursing the wounds they suffered when investing in infrastructure assets pre-2008 that turned out to have a strong GDP linkage, whether or not investors had envisaged such a linkage at the point of investment (a matter of some debate).            

The resulting investor sentiment was witnessed by Wim Blaasse, managing partner of Dutch infrastructure fund manager DIF, when his firm was raising capital for a fund which closed on €571 million in September last year. “LPs were focused on stable cash flows for the long term, especially after they had experienced during the crisis that a lot of infrastructure assets provided much more volatility than expected,” recalls Blaasse. “I think this is still the case.”

But despite the apparent opportunity to invest in core infrastructure – especially in Western Europe, where deal flow is strongest – this is not to say that funds focused on that space have an easy ride when fundraising. For one thing, however compelling an investment story is – and however much revenues may be isolated from developments in the wider economy – it is not surprising when investors are distracted by woe at a macro level.

Earlier this year, for example, raisers of European funds focused on core infrastructure were finding it hard to attract interest from across the other side of the Atlantic as headlines raged about Greece’s financial meltdown and the likelihood of the contagion spreading to other Southern European countries.

Blaasse says that DIF took the decision last year to adjust its strategy to one where it is “reluctant to invest” in the PIIGS countries [Portugal, Ireland, Italy, Greece and Spain]. “Our other markets like the Benelux, Germany and France provide sufficient opportunities,” says Blaasse. “For other funds this might be more challenging because if they stay away from the PIIGS countries not many opportunities will remain.”      

As the Europe debt crisis gathered momentum during the summer, Hans Meissner, managing partner of London-based European fund manager EISER Infrastructure Partners, told us: “Investors in the US say ‘you are sitting in Europe, so explain what’s happened to the euro. What’s your take on Greece?’ They are increasingly reluctant to touch anything European. For US investors, Europe is a difficult sell at the moment.” EISER is seeking to raise €1 billion for its second fund, which achieved a first close in March this year on €277 million.       

Ironically perhaps, following this discussion came the US’ own sovereign debt crisis as the political brinkmanship over the raising of the country’s debt ceiling was followed by ratings agency Standard & Poor’s’ dramatic announcement that it would be cutting the US’ AAA rating. Hence, a matter of a few short months after the experience related by Meissner, Danny Latham, head of infrastructure investments at First State Investments, was telling a very different story of US limited partner (LP) attitudes:   

“What we’ve seen more recently is that, as the investment landscape in their home market has become less rosy, they [US investors] are increasingly comfortable with non-US regional funds. Investors are more agnostic as to region as long as a fund meets their risk/return objective.” Infrastructure Investor was informed by sources that the European Diversified Infrastructure Fund, which First State is currently raising, had collected €600 million by mid-July. 

In terms of the overall picture for infrastructure fundraising, the outlook might best be described as moderately positive. In terms of the bare numbers, the first-quarter global fundraising figures from placement agent Probitas Partners (see boxed item) were fairly alarming as they recorded a slump to just over $2 billion raised in the three-month period, following what was widely assumed to be a recovery in full-year 2010, when $19 billion was raised (compared with less than $11 billion in 2009). However, the market would have been reassured by an apparent return to trend in Q2, when more than $6 billion was collected.

Marcus Ayre is in the optimists’ camp. “Contrast fundraising now with the immediate aftermath post-Lehman,” he says. “Trustees are rational. They’re cautious but they’re still following their investment programmes. Post-Lehman, trustees were consumed with putting out fires in their portfolio and suspended new investment activity.”

There have been some setbacks for the infrastructure fundraising market. Anecdotally, some say there was a point last year when fundraising was gathering steam only for investors’ heads to be turned when it was perceived that private equity may have reached the bottom of the cycle and was therefore offering optimal buying opportunities. Others fear that, as stock markets plunge, over-allocation to alternative assets generally may once again become an issue – as it was post-Lehman – leading LPs to freeze allocations.

Few believe that the bad news on global debt and economic performance will equate to a fundraising meltdown, however. More likely is that LPs will focus all the more intensely on the kinds of relationships that GPs are offering them. “Fees and carried interest are certainly an important point, especially with the bigger LPs,” says Blaasse. “I expect that this will continue and LPs will more closely look at what management fee will be required given the size and quality of the team.”

Hans Meissner says investors are focused on aspects such as carried interest ‘catch-up’. “Although some investors say you should have catch-up because it makes you work harder, most don't want it.” He also says investors like the fact that EISER pays compensation to its team based on the achievement of cash yield targets, and adds that the most common request received is how much money the team is itself committing to its fund. “We put a significant amount of our own money in but we are restricted in the sense that we have not been in existence for very long.”

First State’s Latham says that institutions whose resources are too limited to allow them to invest directly in infrastructure nonetheless want some of the benefits of direct investment when they invest in funds. Examples include low cost of entry, no fees on undrawn capital, fees relevant to the risk profile and a desire for control and transparency around such aspects as the fund’s strategy and level of portfolio gearing. He adds that some managers have “done themselves no favours” by being guilty of “style drift”, and hence can hardly complain at LPs wanting more insight into what they are doing.

Blaasse agrees that “it is crucial for a GP to have a constant dialogue with your investors and be as transparent as possible, given that LPs have become more critical these days. The most important issue we discuss with them is strategy and adjustments to it, like issues around the PIIGS countries and why it would be good to invest more in solar etc.”.

This careful attitude on the part of investors is, of course, no coincidence. In today’s environment, caution is natural and – as mentioned at the outset – the characteristics of infrastructure investment are well suited to the times. Investors “are more focused on minimising risk rather than optimising returns,” Pahari points out. “There is a lot of conservatism around financing and re-financings are appreciated. The focus is not on aggressive leveraging but in positioning assets for a long-term return that has stability through regulatory underpinnings.”

Caution is also leading investors to gravitate towards the familiar and away from the promising but unproven. Hence, emerging markets are – however temporarily – being eclipsed by developed markets in an infrastructure context. “There is a perception on the part of pension funds that emerging markets are more in the ‘alpha’ bucket, and therefore a step too far,” says Latham.

Adds Pahari: “In emerging markets, infrastructure is less a defensive play. So far it has been more of a growth story with various exit strategies including IPOs. In the longer run, what will be emphasised is the need for solid government framework and transparency (which is happening) – and the US and Europe will be prominent.”

Replace ‘sexy’ and ‘stellar’ with ‘safe’ and ‘steady’ and you’re talking the investor language of today. Those infrastructure firms out seeking fresh capital for funds that fit that description should stand to benefit.