Risky business

It’s true that infrastructure is a relatively young asset class, but the emphasis here should be on relatively.

It’s certainly been around long enough to dispel some of the original misconceptions that crept up around it – or at least it should have. But the idea that infrastructure is virtually riskless has persisted as one of the asset class’s most enduring myths, manifesting itself in peculiar ways.

One example among many: Deloitte’s unfortunate branding of institutional investors’ purchase of Norwegian gas network Gassled – an equity investment – as “a high yielding, long-term safe concession-based placement [with a] risk profile […] best described as a Norwegian government bond”. We say unfortunate because the Norwegian government is currently contemplating whether to cut tariffs for future gas transportation contracts by 90 percent.

Still, there are many other misconceptions surrounding the asset class – and they all carry serious risks. Here are three examples of risky behaviour to bear in mind when looking at infrastructure investing.

CORE INFRASTRUCTURE IS SAFE

These days, the risk of breezing into a core infrastructure investment on the back of its perceived safety is so high – especially in Europe – that we are naming it the asset class’s number one risk.

Why are we seemingly and counter-intuitively deeming these monopoly-like, regulated, assets a risky proposition? For a few reasons, actually – some to do with the present moment, others more related to their general nature.

On the ‘present moment’ side, it’s really a numbers game. Right now, every single infrastructure investor across Europe – including a significant number of new entrants – seems to have its sights set on some sort of core infrastructure investment.

As has been widely reported, this level of interest is inflating core infrastructure prices across Europe, creating the risk of overpayment. The latter can have dramatic consequences, especially if you fly too close to the lower end of your returns requirement.

For traditional general partners (GPs), core infrastructure returns in some markets and sectors are already pricing them out; for other GPs, there’s a real risk they will find themselves surrounded in certain countries and/or markets by institutional investors with lower return requirements, leaving them more vulnerable to regulatory risk.

Limited partners (LPs), who often see these investments as little more than glorified bonds, run the risk of looking like the proverbial deer in the headlights when conflicts with regulators, higher than expected capex requirements, and other bumps on the road force them to either roll up their sleeves, or hire somebody to roll them up for them.

Mostly, though, regulatory risk is a clear and present danger, heightened in these budget-constrained times. Put simply, governments are making no secret of their willingness to do whatever it takes to make savings – even if that implies drastic action, like retroactive changes.

A big, over-eager pile of money of money lining up around the block is only going to harden that determination.

JUMPING ON THE BANDWAGON

Not to belabour the point, but the UK’s Pensions Investment Platform (PIP) – a self-described vehicle “by pensions for pensions” – is really shaping up to be a textbook example of what can happen when you are pressured into jumping on a bandwagon.

Initially announced as part of Chancellor George Osborne’s 2011 Autumn Statement, the PIP was touted as the perfect way to get more pension investment flowing into UK infrastructure. On the one hand, it allowed the UK government to claim it was kick-starting infrastructure investment, stimulating the economy and bringing in a new source of capital. On the other, it allowed institutional investors to bypass traditional GPs and create a tailor-made, cheaper vehicle.

Two years on and with little to show, the PIP and its founding members are looking somewhat lost at sea.

For starters, the PIP has yet to define itself beyond articulating its desire to invest in infrastructure. After making noises about its unwillingness to get bogged down in costly fee structures, it has now started searching for one or more potential third-party managers, with the help of financial services firm PricewaterhouseCoopers and law firm Clyde & Co.

In the meantime, its 10 founding members, who, according to Infrastructure Investor Research & Analytics, already have over £3 billion (€3.5 billion; $4.6 billion) collectively invested in infrastructure, have signed £100 million ‘soft commitment’ cheques to the platform. That means they have tied £1 billion of potential infrastructure capital to the PIP, contingent on being happy with its final structure.

While nothing stops the PIP’s 10 founding members from allocating money to the asset class through other channels, it’s highly possible they will wait and see how the PIP shapes up before they do – at least in meaningful amounts.

The lesson here is that there are real risks involved when choosing which structure to use to invest in infrastructure. Botched choices, at the very least, cost time – and if you’re really unlucky, a lot of money.

NOT WHAT YOU HAD PLANNED

It’s an LP’s world nowadays and LPs are not shy about making GPs know it. Whether its fees, track record, or transparency, LPs are making sure they have their cake and eat it. But despite this shift in the balance of power, it’s useful to remind ourselves that, every so often, things don’t go according to plan.

Take the very public dispute between fund manager Henderson and the majority of investors in its Henderson PFI Secondary Fund II.

Investors gave Henderson £573.5 million with a mandate to go out and invest in Private Finance Initiative (PFI) assets. Henderson did that, but with a twist: it used the entirety of the funds raised to buy PFI specialist John Laing.

Its LPs were not amused, especially when the financial crisis and an unfunded pension deficit started to significantly reduce the value of their investment in John Laing.

The dispute came to a head last year, when 22 of Fund II’s LPs took Henderson to court over alleged breach of mandate. A preliminary court hearing boosted Henderson’s case and the LPs eventually dropped the legal proceedings altogether earlier this year. As a peace offering, Henderson footed their legal bill.

Legally, Henderson did nothing wrong and, while its investors are probably still losing money on Fund II, the fund manager can potentially turn things around and exit John Laing in style. But even if it manages to give investors all their money back plus a tidy profit, LPs are unlikely to forgive and forget.

Still, the whole Henderson kerfuffle clearly shows that in infrastructure investing – as with every other asset class – investors will sometimes end up feeling they didn’t get what they bargained for.