Second is best

At our recent Berlin Summit, packed to the rafters with asset class luminaries, one of the questions on everyone’s minds was: “Where is the opportunity in infrastructure today?” Among those weaving their way through the crowds was Pantheon’s Andrea Echberg, who could have provided a one-word answer to that question if someone had stopped her to ask: “Secondaries”. 

Echberg was appointed by the London-based private equity and infrastructure investor in January this year, having previously been head of infrastructure in the principal finance team at Société Générale (where she had responsibility for the French bank’s co-investment programme).

At the time of the appointment, it was stated that Echberg – who joined as partner and head of European infrastructure – would focus on secondary, co-investment and primary infrastructure investments. But it’s when talking of secondaries that Echberg becomes most animated. And with good reason perhaps. While Pantheon cannot comment, it is understood from market sources that the firm is currently talking to investors about a new infrastructure fund that would be largely focused on secondaries and would likely target around €500 million.

“We’re seeing a huge opportunity in the secondary market,” Echberg enthuses. “It’s the kind of niche I would be looking for if I were investing in another fund manager.” She reflects that the secondary opportunity began to emerge in a notable way several years ago, when the value of the opportunity was around $2 billion to $2.5 billion per year. Over the next three years from now, she expects to see deal flow of between $10 billion and $16 billion.

This would see the scale of the infrastructure secondaries market more or less in synchronisation with the longer-established private equity secondaries market, where 3 to 5 percent of primary market deal flow is typically recycled into secondaries.

One of the few

Pantheon knows all about private equity secondaries, having established one of the world’s first private equity secondaries funds – Pantheon International Participations – in 1987, and grown its secondaries assets under management to more than $6 billion. This track record is one of the reasons why Echberg believes Pantheon is one of only a small handful of firms able to lay claim to credibility in the infrastructure secondaries space.

“You need to establish a secondaries platform,” she insists. “We have been in private equity for decades and, in infrastructure, we work very closely with our private equity colleagues. We can work together on things like origination and pricing.”

That said, she also believes experience of infrastructure is required and that to go directly from private equity secondaries to infrastructure secondaries would be a “dangerous game”. Pantheon has been investing in the primary infrastructure market for some time and now has 11 investment professionals covering infrastructure globally, headed by San Francisco-based global infrastructure head Kathryn Leaf Wilmes.

Echberg concedes, however, that Pantheon is currently backing only a “limited number” of general partners (GPs) in the primary market, with the Berlin Summit providing clues as to why a selective approach is needed. “There is a lot of money chasing core infrastructure in safe havens and valuations are at the same level as just prior to the Crisis. That squeezes returns  and we think it’s not appropriate.”

She adds: “Infrastructure has got all the right characteristics as far as investors are concerned, but people have a tendency to overpay, overleverage and move outside the realms of what is really infrastructure.”

‘Right risk-adjusted return’
 
By contrast to the primary market, Echberg believes the secondary market offers “access to a very good asset class with the right risk-adjusted return”. For example, when a consortium including iCon Infrastructure sold water utility Sutton and East Surrey Water to Sumitomo Corporation in February, the multiple to the Regulated Asset Base was reported to be close to the peak valuation of such assets over the last seven or eight years. But Pantheon picked up a secondary position in the same sector understood to be near the bottom end of such valuations over the same period.

As well as the pricing, Echberg reflects that there are “portfolio benefits for investors as well because secondaries remove the J-curve. Funds are largely deployed when you invest so you get accelerated yield. You also have knowledge of the assets rather than having to take blind-pool risk”.

One observation made by those with experience of infrastructure secondaries is that there can be very large differences in the pricing of assets and portfolios, ranging from discounts of just a few percent to 80 or 90 percent. What does Echberg make of this apparent volatility in pricing?

“We do see differences in discounts but discipline is the key thing,” she says. “We look at opportunities asset-by-asset and apply the right valuation in terms of the risk-adjusted return. How we approach it will depend partly on the manager as some of them have a conservative approach and some don’t.”

Returning to one of the big themes of the Berlin gathering, conversation turns to regulation and the impact this has had – and is likely to have – on deal flow. “Regulation has accelerated the market,” asserts Echberg. “A lot of deal flow is coming from the banks, especially in the US and Europe. You have things like Dodd-Frank, Basle and Volcker and we’re also starting to see some impact from Solvency II.”

She adds: “Some asset managers are looking at their portfolios and deciding they’re overweight in alternatives. Others change their strategy when they have a change of chief investment officer. One thing is for sure: financial institutions are starting to react to a changed world and what we’re seeing now is just the tip of the iceberg.”

‘Real interest’

While unable to talk specifically about Pantheon’s fundraising activities, Echberg believes there is “real interest in secondaries”, especially from Germany. “There are investors which manage their own primary allocations but don’t have the capability to do secondaries, which they see as complementary. Many investors know and like secondaries from the private equity side; they already ‘get it’.”

She adds: “There has been an opportunity in infrastructure secondaries for a while, but now at a better price and with vintage diversifiation [due to the increasing maturity of the asset class].”

No wonder Echberg looked busy in Berlin. There were no doubt plenty of people wanting to get her view on the opportunity as she sees it.