The new elite

There is much talk these days of how infrastructure is gradually winning acceptance as an asset class from within the investor community. But this analysis tends to overlook the wholehearted embrace which it received before the 2008 crisis struck. As a reminder, on inception in 2006, Goldman Sachs Infrastructure Partners was able to announce that its Fund I had raised $6.5 billion. And infrastructure’s best fundraising year by some distance was 2007, with almost $40 billion raised globally (source: Probitas Partners).    

This period [pre-Crisis] is described by Arthur Rakowski, senior managing director responsible for institutional relationships at Macquarie Infrastructure & Real Assets, as the “period of rapid growth in the development cycle” of the infrastructure asset class. Talking about the general fundraising environment at that time, he says: “It was a period of exuberance where prudent manager selection and diversification rules were sometimes neglected by LPs. Now we’re back to a traditional type of manager assessment where the focus is on track record, the longevity of management teams and their ability create and preserve value through the whole investment cycle.”

Oddity

Rakowski also points to the oddity of multi-billion dollar first-time funds, something which historically hasn’t happened in other asset classes. But, in today’s economic climate and with the dark cloud of the Eurozone crisis still remaining stubbornly in the firmament, Rakowski thinks things will be different from now on. “Raising a first-time [infrastructure] fund will become as difficult as raising a first-time private equity fund where you’re typically looking at scraping together 50 million from family and friends,” he says.

Anecdotally, there is certainly plenty of evidence of first-timers finding life extremely tough on the fundraising trail. Even Rakowski’s modest proposal of raising tens of millions may be beyond some. But this struggle only serves to highlight the sharp distinction being drawn between the tested and the untested. Witness, as the most obvious example, New York-headquartered fund manager Global Infrastructure Partners’ (GIP) second fund. At the time of going to press, it appeared to be speeding towards its hard cap (revised up in July from $7.5 billion to more than $8 billion) and had already surpassed the Goldman Sachs vehicle mentioned at the outset to become the largest infrastructure fund ever raised. 

There’s no doubt that GIP’s fund ticks plenty of investor boxes, even amid the most rigorous due diligence that many infrastructure fund managers say they have ever faced. Firstly, the fund is perceived to have made some good investments from its debut, $5.64 billion fund which closed in 2008 – leading to hopes that the internal rate of return on the fund will be in line with, or higher, than expectations. Secondly, it is cashing in on the trend which favours independent funds over the captive investment banking model that burnt some investor fingers.

A third factor [in the success of a fund like GIP] is to do with US investors being “keen to invest in infrastructure but who do not see investing in European funds as the thing to do” in the words of Alain Rauscher, chief executive of Paris-based fund manager Antin Infrastructure Partners. Indeed, the lack of appetite from North American investors fazed by the Eurozone crisis is cited by many European general partners (GPs) seeking to raise funds. “US investors – especially pension funds – being currently in a ‘wait and see’ position vis a vis Europe is a major limiting factor,” says Rauscher, who adds that insurance companies, on the other hand, “tend to have a different view”.

Another consideration is that, while the infrastructure fundraising market is generally subdued, an elite group of GPs appears to be emerging, with GIP at the forefront. These funds, often raising their second funds and with an established track record, have gained investor trust and seem able to benefit from a fundraising tailwind rather than the strong headwinds that afflict most of their peers. Among this elite might be included the likes of Meridiam Infrastructure and EQT, which in July had raised €1.1 billion on its way to a €1.5 billion target after just six months on the fundraising trail.   
 
Against the grain

But while many of the factors behind GIP’s successful fundraising are easy to understand, it is going against the grain of infrastructure fundraising in at least one important respect. As a private equity-style fund manager, GIP stands apart from the core infrastructure proposition that is believed to be most popular today as investors flee to safe havens. “What do most institutions that invest into infrastructure want? Core infrastructure,” asserts Rakowski. “Moderate returns with low risk are, and will remain, the part of the market that accounts for the bulk of investor interest.”

“More capital is going into safe havens and that doesn’t surprise me,” says Joyce Shapiro, managing director of infrastructure and real resources at Franklin Templeton Real Assets Advisors. “There is a general move to safe havens and infrastructure is no different. Investors want yield and security of capital and there is a lot of opportunity in developed markets. There are additional construction and operational risks one can assume in a developed market to move up the value scale.”

In part, the hunger for core infrastructure is being driven by the poor return from bond markets, which means that “quite a number of investors are expecting to increase their infrastructure allocations,” according to Wim Blaasse, managing partner at Amsterdam-based fund manager DIF. For investors in bonds, the transition to core infrastructure is evidently more natural than would be a move to opportunistic investment.

The shift to safe havens was strongly hinted at by a recent survey from Probitas which found a “steep increase” in respondents de-prioritising emerging markets. In the equivalent survey in 2010, 48 percent of investors said they were interested in emerging markets because of their long-term growth potential. Two years on, this figure had tumbled to 25 percent.

Furthermore, at the height of interest two years ago, only 20 percent of respondents rejected emerging markets because of concerns about political, economic or currency risk. That figure has this year more than doubled to 45 percent. And, as well as “heightened risk”, the survey concludes that investors are anticipating less organic economic growth in emerging markets as well.

Singapore-based Equis Funds Group, which has an appetite for investing in south-east Asia, appears to be defying this negative attitude to emerging markets. In July, its debut fund had raised almost $400 million of its $500 million target with market sources predicting it could reach its $750 million hard cap by the end of the year.

‘Dwindling’ captives

Equis’ chief executive David Russell thinks that more investors should be allocating capital into emerging markets, particularly Asia. But on the one hand, he sees investor interest in captive offerings “dwindling”. On the other, there is only a small population of independent infrastructure funds in Asia, with the possible exception of India. “There are not that many independent GPs with experience and track record in Asian infrastructure,” Russell asserts.

Russell also believes the investor strategy of joint venturing with Asian financial institutions may lead to investor frustration. “You ask your local bank manager to lend you money not identify the house you wish to purchase, so why do so many investors joint venture with local institutions with little or no history of infrastructure investment?” Russell notes. 

The love affair with certain traditional sectors of infrastructure such toll roads, may also lead to disappointment, says Russell. “The sector has a history of traffic over-forecasting, competition for minority stakes and suddenly you are hoping for capital market improvements and earnings re-ratings to get you out of your investment.  Why aren’t investors undertaking an in-depth analysis of the power and energy sectors, the first and most fundamental sectors for growing economies and where government policy initiatives are creating and incentivising investment?”

Russell says the key is to focus on Asia’s growth markets and on those sectors that are undergoing transformation. As an example, he points to the solar sector in Thailand where Equis was reported to have done a $200 million deal in August. The firm is thought to be targeting other solar energy portfolios and looking at countries including Malaysia, Indonesia and the Philippines as well as Thailand.

Ultimately, Russell hopes that more experienced independent managers will arise to assist with investor understanding, help grow the market and take advantage of the opportunity that undoubtedly exists in Asia. “I hope [the emergence of new managers] is just a product of time,” he says. “It’s a developing market but the need for infrastructure finance and associated returns are enormously compelling. Asia must attract capital in the end.”

And in the end, it surely will. The same survey from Probitas referred to earlier also found that 70 percent of respondents wanted to either keep their infrastructure allocations the same or increase them in 2012 while “almost none” said they had a decreased appetite. In 2011, over 60 percent said they were without a specific allocation to infrastructure – by this year that figure had fallen to 37 percent.

The challenge for limited partners is to find ways of effectively channeling capital into a still immature asset class. Once they do that, the fundraising climate – not withstanding that dark Eurozone cloud – will improve. And the benefits will be felt beyond the ‘new elite’.

INNOVATE OR DIE 

Infrastructure funds are putting their thinking caps on as they ponder how to attract investors in a tough climate 

Management fees may still be what market participants artfully describe as a “key discussion point” between infrastructure general partners (GPs) and limited partners (LPs), but the headline rates are perhaps the least interesting aspect of this discussion – having apparently settled at norms of around 1.5 percent for value-added funds and 1.0 percent or a little less for lower-risk, core infrastructure funds.

But other aspects of compensation have seen the application of plenty of grey matter in order to try and find the right solution. One recent development has been sliding fee scales depending on the level of investor commitment, with the biggest commitments benefitting from the lowest fees (as well as sometimes being granted other perks, such as rights of refusal over any secondary positions being sold by the fund).

In an increasing number of funds, blended fee rates are being seen with respect to invested and uninvested capital. On this point there is a potential pitfall described thus by Shawn D’Aguiar, a partner in the Private Funds Group at law firm SJ Berwin: “You don’t want to incentivise managers to do deals quickly just so they’ve got the money they need to run the business.”

What has also been seen is the tendency to develop “hybrid funds” that effectively mix the “open” and “closed” model – one example being First State Investments’ European Diversified Infrastructure Fund, which started as an open-ended fund in 2007 and then changed to a hybrid model in 2011. The hybrid model is comprised of a 15-year initial life, with investors given the opportunity to vote in favour of fund extensions in five-year blocks.

In this type of hybrid model, if an extension gains the requisite number of votes in favour, those investors who have voted against the extension may be granted liquidity options. Another feature of some hybrid models is the option to terminate the fund if it has failed to hit a pre-agreed minimum level of return.

A growing feature of infrastructure fund structuring these days is so-called currency collapse clauses. It doesn’t take a genius to work out that the possible collapse of the Euro has precipipated this development. In the event of such a grave scenario, a Euro-denominated fund benefitting from such a clause would be able to switch to an alternative denomination such as the dollar or pound sterling.

Clauses around regulatory risk are also becoming more common, where, in D’Aguiar’s words, “you have the flexibility to make changes to funds to allow for developments arising from new laws such as the Alternative Investment Fund Managers (AIFM) directive”. He adds that changes to the terms or structure in response to laws – where those changes are optional rather than necessary for compliance with law – may go to a vote of the fund’s advisory committee or to investors.