LP Perspectives: Keep fees down and carry on

Ever heard of the graduate’s curse? The graduate is trying to find an internship at a blue-chip company, but at every door knocked on someone tells them they don’t have enough experience – which of course is why someone looks for an internship in the first place.

To some extent, this sort of chicken-and-egg situation also applies to a proportion of the fund manager community. Despite the youth of infrastructure as an asset class, the absence of real benchmarks and the relative scarcity of long-established players, investors seem determined to find advisors capable of demonstrating one single key attribute: persistence. Being able to generate a repeatable track record beats other issues in the mind of LPs, with an overwhelming 89 percent of respondents putting it in their top-three GP-related concerns.

Next down the list are items that confirm LPs’ focus on GP stability, coherence and consistency. About 26 percent of them choose team stability and retention strategy as the area they scrutinise most when selecting managers, while a similar proportion thought strategy consistency represented a major box to tick. Another important area of focus was the presence of a proven operating model, conceived both as a guarantee that managers know how to run assets to generate yield as well as add value to them in the long term.

“It remains a relatively young category so people are still in the honeymoon phase. As time will pass in the coming four to six years we will see more and more funds needing more liquidity and I’m not sure the liquidity will always be there,” comments a Dutch-based investor.

Yet strong, reliable performance comes at a price, a subject that continues to underpin serious negotiations between LPs and their fund managers. The current level of management fees tops our list of GP reward issues, in front of the current level of carried interest and waterfall arrangements. Less of a concern are the ability to offer preferential terms to larger investors and structuring separate accounts.

Investors nevertheless willingly recognise, as far as fees are concerned, that there’s been significant progress since the outbreak of the Financial Crisis. “It’s less an issue today than it was four or five years ago, when a number of infrastructure funds started with a classic private equity, 2-and-20 fee model. A number of managers have gone down on fees or adopted more flexible fee structures,” reckons Yielco’s Fleischhauer.

LPs have also moderated their initial demands. “Driving down fees to stupid levels just means the management isn’t properly remunerated and incentivised to do the best for you. So we’ve been trying to drive reasonable bargains where we can,” says Finnie of Strathclyde.

Engagement with ESG principles did not come top of the list of GP-related issues but it was encouraging to see it mentioned by about 40 percent of investors. It even came before succession planning as a key area of managers to focus on, which came to the mind of only 30 percent of LPs. This may indicate that in tighter-knit firms few founders are about to retire – perhaps as a result of the asset class’ relatively young age – while in larger organisations infrastructure has inherited from institutional processes deemed capable of ensuring smoother transitions at the top.