It comes as no great surprise to learn that Peter Hofbauer is a golf fan and, as we speak, is tempted by the May sunshine to contemplate the prospect of a leisurely stroll around some fairways over the approaching weekend. After all, golf is both relaxing and intense at the same time – a pleasant walk between shots punctuated by a demanding challenge each time the ball is addressed and then struck.
Hofbauer, head of infrastructure at London-based private market investment firm Hermes GPE, demonstrates this mix of relaxation and intensity as we speak in the firm’s Portsoken Street offices on the fringes of the City. An affable and welcoming individual, he becomes a picture of concentration when asked questions – treating them all as complex brain teasers deserving of a forensic level of mental processing (which, in at least some cases, seems unduly flattering).
This cerebral approach appears entirely in keeping with that of Hermes GPE’s approach to investing the more than £2.5 billion (€2.9 billion; $3.8 billion) of capital it manages on behalf of its clients, i.e., it’s in no hurry whatsoever. Or, as Hofbauer puts it: “There is no set time period for investing the money.” You sense this suits him down to the ground: after all, he has all the time he needs to apply his mental powers to deciding whether an investment makes sense or not.
This absence of a specific time horizon has an added significance. At the current time there is talk of asset price inflation in the core infrastructure space where Hermes GPE operates – were the firm in a rush to the put the money to work, its ability to meet clients’ return expectations may be compromised.
Even so, Hofbauer acknowledges the pitfalls. “We are cautious about valuations,” he says. “There has been a lot of central bank-generated liquidity and the Bank of England has made a pertinent assessment of resultant increases in asset prices.” Earlier this year, then Bank of England governor Sir Mervyn King spoke of how loose monetary policy had fuelled over-optimism in financial markets. He hinted that, in the search for yield, risk was not being fully priced.
Such warnings are by now very familiar to those investing in core infrastructure. Hofbauer thinks there is another reason why alarm bells should be ringing, and it’s one that’s arguably less publicised. “Where investors are buying assets on a return relative to current low real interest rates, they may be impacted if real interest rates increase. This impact will be greater on investments that display fixed rate characteristics rather than floating rate characteristics.”
All this explains why Hofbauer says there is a difference between “what’s available [in terms of deal opportunities] and what filters through to the investment characteristics that we want”. And what Hermes GPE’s clients broadly want is a replacement for fixed income “at the conservative end of core”.
So far, there have been only a couple of examples of what this translates to in reality – one of which was a minority stake in UK utility Thames Water in May last year on behalf of its biggest client, the BT Pension Scheme (BTPS). Frank Naylor, head of strategy for BTPS, described Thames Water at the time as “a well established business governed by a mature, transparent regulatory regime that should provide predictable inflation linked cash flows over the long term”.
Shaping the industry
Hofbauer hints at the benefits of long-term institutional ownership that the UK government has been so keen to encourage when he says of Thames Water: “We’re engaged at the company and industry level to shape the development of the industry and add to its attractiveness – for example through lower leverage, which the regulator supports as well. Deals like this represent an evolution to long-term institutional holders from the originators, including the GPs [general partners] that took a number of them private.”
A second example of Hermes GPE investing at the “conservative end of core” came when it acquired a portfolio of rooftop solar panels towards the end of last year. “It was subject to a FIT [feed-in tariff] regime, fixed for 25 years and was acquired without third-party leverage. There was some operational volatility – albeit quite small – but there was visibility of current and future performance and it was a high EBITDA margin business”.
He adds: “There is no prior claim on the cash flows, the yield is strong, there’s little volatility and it’s 100 percent indexed to RPI [Retail Price Index].”
All of this underlines the point that Hermes GPE can afford to bide its time, waiting for the asset with precisely the right characteristics to come along. As the manager of UK pension money it also finds itself in what Hofbauer sees as a privileged position.
He explains: “There is a dearth of local, UK institutional investors around and the reception we get is very positive. There are not many UK institutions on the roster. The private side is dominated by international pensions and sovereign wealth funds. We’re a local partner of choice and to date we have been welcomed by management, vendors and partners alike.”
This engagement was secured once BTPS decided on a 5 percent allocation to infrastructure at the end of 2011, hiring Hermes GPE to tailor the outcomes that it wanted from its £2 billion commitment. Although the Thames Water investment was made in the interim, the allocation did not get final sign off until the back end of last year.
Describing their client’s motivation, Hofbauer says: “Our client wanted to be co-investors on a direct basis as they had scale and they saw that option as better than pooled investment vehicles. Plus, they were uncomfortable with all the agency and fees issues around pooled funds.”
£3bn the limit
Including “a range of other clients of a different scale and risk expectations”, Hermes GPE now has “north of £2.5 billion” under management in infrastructure. Hofbauer says £3 billion would likely be the limit in terms of capacity that Hermes GPE’s seven-strong team would want to manage. A longstanding private equity and private debt investor, the firm managed £6 billion in total on behalf of institutional investors and pension funds at the end of last year.
As he gazes out of the window, Hofbauer may be thinking of a golfing weekend in the sun. But for now, he draws the conversation to an end by insisting that work still needs to be done – even on a Friday. He may not be in a rush, but that doesn’t mean he’s not busy.