From prix fixe to à la carte

There are good sides to being constrained to a prix fixe (fixed price) menu. You save precious time and energy by not dithering over an array of appetising options. You don’t have to know much about ingredients and courses, since they’re already chosen for you. And you can have both starter and dessert without feeling too guilty.

That’s how it was for infrastructure investors a decade ago. Taking their inspiration from private equity, most fund managers offered access to infrastructure via a typical 10-year, unlisted, closed-ended vehicle; fees also followed a formula close to the buyout classic of ‘2 and 20’. And that seemed fine: infrastructure investors, eager to climb the infrastructure learning curve, were generally happy to let themselves be guided.

But things have changed. Fund managers have realised that trying to capture the vast heterogeneity of infrastructure assets in a single model doesn’t always work. Meantime, limited partners have grown more knowledgeable and more demanding, and the macroeconomic climate has put an emphasis on features such as current yield and liquidity. Rising competition, meanwhile, is driving fund managers to seek differentiation.

The result is a richer, more diverse landscape, where varied propositions can serve the needs of a wider range of institutions – at the risk, sometimes, of confusing them. Below, we sample a few of the options available to today’s LPs.

THE OLD CLASSICS

You don’t have to look very far to grasp that private equity-style vehicles remain a staple of the infrastructure fund business. The largest fund closed last year – and the second-biggest ever raised – was Brookfield Infrastructure Fund II, an unlisted, closed-ended vehicle with firepower of $7 billion.

There are good reasons for the model’s persistence. Closed-ended structures, it is said, allow for efficient decision-making and deal execution. The formula is well known to investors, and many fund managers have experience of offering such products in other asset classes before. And fees involving both a base remuneration and carried interest – provided they are well calibrated – continue to be viewed as offering a good alignment of interest.

Nor does the format preclude funds from adopting widely different strategies: blockbuster funds such as Brookfield’s co-habit with mid-market vehicles such as InfraVia’s European Fund II, closed last August on €400 million. Others have a clear sector mandate, like Terra Firma’s green energy fund, or a regional focus, such as MENA Infrastructure’s Fund II – both of which are currently being raised.
Some fund managers have also tweaked aspects of the old model. Paris-based Ardian, for example, last year closed a €1.45 billion fund that indexed fees on current yield rather than capital returned. Brookfield’s Fund II, meanwhile, has a 15-year tenure instead of the typical 10-year term.

THE LONG DRINKS

Other firms have made more substantial changes to the original proposition – by extending the duration of their fund to an extent rarely seen in other asset classes. The idea here is to capture more of the revenues generated by long-lived infrastructure assets.

One fund manager to have gone down this route is Meridiam Infrastructure, whose flagship funds have a tenure of 25 years. In the case of Meridiam, which tends to target greenfield assets with concession terms of up to 30 years, the formula has clear advantages: the capital is locked in for the long term, allowing the firm to concentrate on sourcing and operating assets rather than spending much of its time courting investors.

The structure also caters well for the needs of pension funds and insurance companies, whose liabilities span several decades, as well as large sovereigns, some of which would rather have their money parked for several decades than go through the investment process again after a mere 10 years.

Notwithstanding these undeniable strengths, few longer-dated vehicles have made it beyond the drawing board. As the chief executive of a ‘classic’ fund puts it: “When I say I’ll be around in 10 years to give them their money back, most investors trust me. But for many it’s hard to be so sure when you’re talking about 25 years.”

THE FULL-ON BANQUET

The market counts more and more examples of open-ended funds – both established platforms and recent initiatives.

Australia’s Industry Funds Management, for example, has been operating in the field since 1994; it recently set up a fresh unit in Japan. But New York-based JP Morgan started its offering in 2007, while Canada’s Fiera Axium launched an open-ended platform at the end of last year with a target of $971 million.

A variant of open-ended funds are listed vehicles, the number of which has risen over the last few years. London has proved a hotbed for them, whether it be in the social infrastructure space (HICL, INPP, JLIF), or, more recently, renewables (Foresight, TRIG, NextEnergy).

Most evergreen funds include a lock-up period, setting a minimum time during which investors must retain their share; some offer reduced management fees when limited partners pledge their loyalty for longer.

Evergreen structures look well-suited to infrastructure. Critics of closed-ended vehicles think it artificial to exit long-lived, cash-yielding assets after a pre-defined number of years. Open-ended funds, they say, reassure investors by providing more liquid investment than blind-pool vehicles. It is also argued that they provide more transparency on yield and valuations.

Critics suggest, however, that open-ended structures are not as resilient as they seem. “The perception of liquidity is probably a bit over-egged,” says a placement agent, who thinks their fortunes could turn in times of crisis. “What happens if everyone runs for the exit?”

THE SHARING PLATTERS

The rising popularity of infrastructure has prompted the emergence of structures designed to help investors too small or inexperienced to build a fund portfolio. Here too, the idea came from established asset classes such as private equity where funds of funds have long sought to garner capital from smaller institutions in exchange for guidance and access to top-performing managers.

The phenomenon is still young in infrastructure, but a number of actors are intent on spearheading the move. These include investment houses like Switzerland-based Capital Dynamics, as well as more specialists players like France’s Quartilium or Germany’s Golding Capital Partners. A key selling point here has been the ability to offer a diversified portfolio: Altius’ latest fund of funds vehicle, for example, targets the broader remit of real assets.

Sceptics doubt the funds of funds market will grow much bigger, however. ‘Intermediate structures’, they say, find it harder to justify another layer of fees in an asset class that offers comparatively low returns. Fund managers also argue that gaining access to top-rated vehicles, amid rising competition for funds, is not as hard as it used to be.

THE HOUSE FUNDS

Some investors have gone in the opposite direction, attempting to form their own platform without the help of a fund manager.

Sometimes one experienced institution has taken the lead and tried to lure in relative newcomers to the asset class: this is the role played by Ontario Municipal Employees Retirement System (OMERS) in the Global Strategic Investment Alliance, a platform set up by the Canadian pension alongside Japanese LPs which targets $20 billion. Sometimes the initiative is led by governments or development finance institutions, as in the case of the European Union’s Marguerite Fund or the Philippines’ Investment Alliance for Infrastructure Fund.

In other instances, such as the UK’s Pensions Infrastructure Platform (PIP), investors team up first before agreeing on a fund manager that will build and manage their portfolio of assets.

The rationale behind such platforms is simple: a desire to cut fees, have greater discretion over investment decisions and network with like-minded institutions. In practice, though, they generally have not progressed as fast as hoped. The Marguerite Fund took 14 months to be set up, for example, while the PIP and GSIA are still some way off their original targets.

This suggests orthodox fund managers will remain key partners to investors in years to come. But their continuing quest for the right model will keep providing the market with abundant food for thought.