India’s uphill battle

India’s infrastructure market is proving increasingly tough for private investors. The number of private investments closed in Indian infrastructure fell from 51 in 2007 to just 18 last year, and the total amount of money invested dropped 83 percent from a peak of $28.7 billion in 2009 to only $5 billion last year, according to Infrastructure Investor Research and Analytics.

Given the phenomenal demand in the country – the government estimates it will need $1 trillion in infrastructure investment over the next five years, half of which must come from the private sector – the strong aversion that international investors appear to have developed may seem unreasonable. Just walking down a road in any Indian city, the potholes, slums and congested traffic suggest private investors should have much to offer.

Unfortunately, returns on infrastructure investment have largely matched India’s infrastructure: poor or non-existent. Few infrastructure funds in the country have been able to generate outstanding returns for their investors, to say nothing about difficulties with execution as projects get held up.

Now that India’s infrastructure “honeymoon” is over, what happens to the players who still want to stay in the county and raise infrastructure funds?

Tigers in the jungle

Despite the scepticism, some infrastructure investors in India are refusing to give up. Indeed, IDFC Alternatives, the alternatives asset management arm of Indian finance giant Infrastructure Development Finance Company (IDFC), recently told Infrastructure Investor that it has launched a new $1 billion infrastructure fund, and expects to hold a first close soon.

Australian bank Macquarie is also understood to have invested $900 million of its $1.2 billion Macquarie-SBI Infrastructure Fund (MSIF), a joint venture fund with the State Bank of India, and may be looking to fundraise again, though details have not been disclosed.

The secret behind the few fundraising successes in India, according to industry insiders, is simply that institutional investors are becoming far more selective. Thus, to raise any funds, managers must be willing and able to hear institutions’ demands and adjust their fundraising and investment strategy accordingly – though this may be painful for the funds themselves.

“Investors have become much more conservative,” says one Mumbai-based international investor. Institutions will no longer take the fund manager’s word at face value, he says: they want to know how the fund will invest and what the risk-return profile of each asset is. For example, although IDFC’s first fund has returned 15 percent of its capital to investors, its chief executive MK Sinha has no doubt the new fund will incorporate more club deals with its LPs. “That is what helps draw in more investors and money.”

The real battle that the world’s second-largest country by population fights is with its image. A largely liberalised infrastructure investment market has not been enough for private investors to get their expected returns, and the cause of the deadlock is two-fold, according to a Mumbai-based fund manager.

First, many infrastructure investments “were treated like quasi-private equity,” he says. Investors expected to put in money, do an IPO in three years and get out. That strategy was predicated on significant expansion, and after the onset of the Global Financial Crisis it simply didn’t work.

“That’s just not the way to view the sector,” the GP tells Infrastructure Investor. “An Indian investment has to have seven to eight years, or a minimum of five years. That’s simply the time you need to stabilise the asset.”

The second problem with the sector came with execution. Processes such as land acquisition and compensation are not universal across India’s 29 states, and the private sector partner can easily misunderstand its responsibilities. Getting a project to the point where it produces cash flow then becomes much harder.

“There hasn’t been a common understanding of what returns need to be in place for the private sector partner,” says IDFC private equity partner Raja Parthasarathy. He adds that the Indian government eventually has to see that “if you don’t get [the private sector] those returns, next time around you won’t get bids.”

Unfortunately, the misunderstanding has led to project after project being delayed in the past few months, with time still ticking on repayment of loans.

The few, the proud

With the hope of private equity-type returns up in smoke, the number of limited partners interested in an Indian infrastructure funds has narrowed significantly. Since many international investors were burned in the first wave, few are eager to take on development risk anymore. In addition, investors are beginning to understand that they need longer-term capital to play the infrastructure game, and not all have that kind of capital available.

For example, according to Sinha, domestic institutional investors – from banks to insurance companies – simply don’t have the cash needed for infrastructure. Building assets like roads, power plants and airports takes so much capital over such a long period of time that only international investors can fill the need. Commitments from domestic institutions are pittance by comparison, he says.

“For example, the [Life Insurance Corporation of India] would not look at a commitment of more than INR1.5 billion to INR2 billion, which translates to about $30 million,” Sinha explains. “That really doesn’t move the needle for infrastructure.”

In addition, domestic institutional investors General Insurance Company of India (GIC) and Employees Provident Fund Organisation (EPFO) tell Infrastructure Investor that they will only consider infrastructure projects that are listed and rated on the Indian stock exchange.

The few institutional investors that are left in the Indian infrastructure game are looking to make fund investments as close to direct investments as possible, the Mumbai international investor says. “LPs want certainty in project documents, concessions… and they are increasingly asking for more involvement, more rights in the funds,” he explains.

Most institutional investors that can do so will be looking for direct opportunities, simply because it gives them more control and they don’t have to pay management fees. Indeed, the source claims that all major institutional investors are talking about setting up infrastructure teams on the ground in India, and some big ones like GIC and Temasek already have them. The next three to four years won’t see too many infrastructure funds on the scene, he believes.

However, Sinha is quick to point out that a good number of interested institutions – such as US pension funds or insurance companies – simply do not have the bandwidth in India to do direct infrastructure, since they need “feet on the street”. These are the LPs that Sinha believes funds should target, and for its fundraising IDFC is relying primarily on its relationships with past LPs.

The opportunity for funds is certainly out there. Based on the $1 trillion need, Sinha estimates that there will be between $35 billion and $37 billion of investment opportunities for infrastructure funds, “which means we can take our pick of projects,” he says. The critical element will be convincing institutional investors of the fund’s strategy.

“To invest in our fund, the LPs really need to evaluate us as a manager, and be confident that we know this stuff,” Sinha says.