“I have one advice to give someone who’s raising a fund: go to bed early and have a good night of sleep.”
This assertion, made by a fund manager Infrastructure Investor recently quizzed for fundraising tips, may have been a light-hearted way to avoid giving away trade secrets. But it still conveys a sense of how personally taxing the whole exercise remains – despite the infrastructure asset class’s growing appeal among institutional investors.
These travails are not dissimilar to what elected politicians have to go through every few years. Fund managers and officials alike have to prepare for a new cycle even before one is finished. Investors sometimes complain that managers spend more time raising funds than doing their day job, just as voters have qualms when their leaders focus more on politics than policies. In both cases, the outcome of a campaign is known only after election results are revealed – or a fundraising close is achieved.
By such standards the year has been a good one so far for incumbent fund managers. Only last month, the UK’s Hermes Infrastructure beat its £800 million (€1.1 billion; $1.2 billion) target by raising £1.16 billion; while Munich-based Golding Capital Partners closed an infrastructure fund of funds on €590 million, above its original €400 million aim. These followed a similar feat by London-headquartered iCON Infrastructure, which reached an €800 million first and final close on its third vehicle in just three months.
A few weeks prior, San Francisco-based Oaktree Capital Management had garnered $1 billion for its fourth power fund; the US’ Kohlberg Kravis Roberts reached a $2.5 billion second close on its second infrastructure vehicle; and New York-headquartered I Squared Capital collected $3 billion for its debut fund, the largest first-time infrastructure vehicle raised since 2009. All this after a year that saw the likes of Antin Infrastructure Partners, Macquarie Group and Infracapital received similar votes of confidence from their investor bases.
One shouldn’t conclude from this impressive list that raising a fund is nowadays a done deal. “It’s always a long slog and a lot of work,” says Edward Nelson, a partner at New York-based law firm Gibson Dunn. “You can’t get out there and hoover up money like in the pre-Crisis years,” agrees James Wardlaw, a partner and head of infrastructure at placement agent Campbell Lutyens.
Such efforts happen in a context where large investors, awash with cash and willing to invest it more fruitfully, are earmarking increasing amounts of capital to the asset class. This appetite has been going strong for a few years already – but according to Martin Lennon, co-founder and head of Infracapital, the continuing desire for yield means it is showing no sign of abating.
If anything, notes Mathias Burghardt, head of infrastructure at Paris-based fund manager Ardian, the trend is gaining even more momentum. “The picture is different than during past fundraises, when the infrastructure asset class was not yet established. Now it’s a must-have allocation.” He reckons Northern American institutions, which showed reluctance to invest in Europe during the height of the euro crisis, have warmed up to the continent.
New limited partners (LPs) are also coming into the fray. “I can’t think of a market with large pools of pension fund, insurance or sovereign wealth fund capital that is not setting up or increasing existing allocations to infrastructure,” says Adam Lygoe, a managing director at Macquarie Infrastructure and Real Assets. Among the new fronts being opened are Japan and Korea, where large pensions are finally opening up to infrastructure, and Germany, where LPs are seeking to replace fixed income.
A number of early investors, admittedly, have now taken the direct route. Frank Roeters van Lennep, head of infrastructure investments at Dutch pension administrator PGGM, says his institution now deploys 90 percent of the capital it invests in the asset class outside funds – Macquarie being the sole manager it still actively commits to. It otherwise sources investments in-house or, when the typical size of deals in areas it targets is too small to justify a team, through partnerships with developers.
But even among large experienced investors, funds still retain a role. Though her ambition is to grow her team from six to nine people, Wendy Norris, the Australian Future Fund’s head of infrastructure and timberland, says committing to third-party vehicles is an integral part of her strategy to construct and diversify the fund’s portfolio.
The institution has a habit of forging deep, long-term relationships with its chosen managers, she explains, in return for which it asks for “very clear” co-investment rights and visibility in the investment process.
Institutions like PGGM and the Future Fund, furthermore, are the exception rather than the rule. As Wardlaw observes, few LPs have the combined ability to source opportunities, execute deals and manage assets, meaning they will continue to access the asset class through funds. Marc Meier, a vice-president at private markets specialist Partners Group, says smaller investors meanwhile tend to start with investing in funds of funds.
Yet the sheer volume of capital looking to access the market is creating its own challenges. “The low interest rate environment is skewing investors’ vision of where the real risk lies in operating infrastructure assets,” notes Ross Israel, head of global infrastructure at Brisbane-based asset manager QIC. This is feeding huge demand for brownfield, core opportunities, creating a relative scarcity of assets in OECD markets.
This state of affairs is having a direct impact on fundraising. Many investors have gone through a number of vintages and various cycles of development, says Lygoe. As they grow more sophisticated, they also become clearer about what they want. “Investors are more professional. They know what to look for during due diligence,” notes Burghardt. And what they’re primarily concerned with, before entrusting someone with a mandate, is getting increasingly plain: managers are requested to demonstrate their ability to successfully deploy money.
“There’s a lot of money around, but it doesn’t mean it’s become easier to raise. Managers have to get confidence from investors that they can source assets,” explains Michael Halford, head of investment funds at law firm King & Wood Mallesons. As such, says Lennon, limited partners are now separating the wheat from the chaff by focusing on “proven teams”. That generally implies digging into track records more than in the past, adds Nelson.
“Often prospective investors will want to meet the back office as part of the due diligence, which few would have done five or six years ago. And the fact that managers operate in a more crowded space means there’s more concerns that sponsors have the network and contacts required to find and execute desirable deals.”
In this context the focus on fee levels and performance targets, hot topics since the Financial Crisis, seems to have somewhat faded. “We didn’t spend much time talking about costs and returns. What investors want is an attractive risk-adjusted return in the current environment,” confides a source at a fund manager recently successful in closing its latest vehicle.
AMEND AND EXTEND
One notable feature, says Hans-Peter Dohr, a managing director and head of advisory at Munich-based DC Placement Advisors, is the move towards charging fees on capital deployed rather than committed. This reflects investors’ worries about deal scarcity. But otherwise most observers reckon fees haven’t moved in a significant fashion.
“Infrastructure already has a more tailored fee structure than private equity,” notes John Campbell, co-founder and chairman of Campbell Lutyens. He says long-term, core funds tend to target returns close to 7 or 8 percent and charge about 50 to 75 basis points; shorter-term, value-add vehicles meanwhile generally aim for returns above 15 percent, with a 150 basis point fee and a 1 percent cut on profits.
This also shows how the asset class, while young compared with its alternatives peers, has evolved towards offering a wide spectrum of opportunities to investors. “Managers now have more wiggle room to rethink their terms a bit. When the market is really tough, people want to raise the exact same fund. But in an easier climate managers have more flexibility to consider terms that are more appropriate for their model,” says Ed Hall, a partner at King & Wood Mallesons.
Some funds have stuck to the traditional 10-year plus tenure. Others now incorporate built-in mechanisms for extension, typically two years at the discretion of the general partners and a further two decided through a vote among LPs. A handful of managers have set up longer-term vehicles, which co-exist with open-ended structures and listed funds. On that point, Halford notes a partial convergence between both models.
“Private equity-style funds are adopting longer tenures, while open-ended structures are becoming more closed-ended, with a drop-dead date and restrictions on redemptions.” What this amounts to, however, is a gradual evolution rather than proper innovation. “There’s more effort to tie the life of funds to the lives of their assets. But nobody’s reinventing the wheel,” Nelson comments.
This relative continuity of fund structure is somewhat counter-intuitive: across most markets, toughening competition generally drives participants to invent new products. But that’s because innovation is happening elsewhere, contends Lygoe. “Fund managers are being more creative in how they source transactions.”
THE RIGHT ANGLE
Wardlaw observes that firms which have recently managed to raise funds in a record time are those that have proved able to “truffle out opportunities outside the auction process”, thereby “avoiding the winner’s curse” of paying too much. That presupposes having a sound and well-targeted investment strategy, he says. “There’s a reason why a lot of funds don’t get raised. They’re just not so distinctive.”
It is important that managers show clarity and consistency in their approach, argues Paul Malan, a senior partner at iCON, especially when it comes to raising follow-on funds. But that doesn’t preclude them from venturing into new areas – provided the move plays to their strengths and is adequately explained to LPs.
For a counter-example, says Dohr, look at the U-turn US-based Alinda Capital Partners did on its latest fundraising effort. He says the firm’s second fund, which closed in 2010 on $4.1 billion with a value-add mandate, was a “massive success”. But Alinda too soon followed by attempting to raise a core infrastructure fund – a diversion of strategy which was not well understood by investors, he reckons. The film folded the vehicle last March, and instead launched a value-add fund with a $5 billion target.
By contrast Dohr believes the latest move by Sweden-based EQT, which has traditionally targeted value-add opportunities but recently started raising a yield-focused vehicle, is cleverly marketed. “Core and value-add are two strategies that have always existed side-by-side. You focus on one or the other. But yield is different: it is now a prerequisite for any investor in any fund.”
Other investors are trying to gain an edge by launching greenfield-focused units or assembling platforms – through aggregating a series of acquisitions into larger entities over time – rather than taking single large positions. “There continues to be disaggregation opportunities in certain sectors where a manager can split out the complexity of a transaction. That brings differentiation relative to classic core assets, which tend to be very well packaged and heavily bid for,” Israel says.
The current quest for originality in deal sourcing is likely to continue. “The market is getting increasingly concentrated: more money is being raised by fewer fund managers,” Burghardt notes. But he says this can’t go on forever: a number of would-be LPs – typically those without existing relationships to incumbent GPs – complain that they rarely have the time to get the checkbook out of their pocket before blue-chip funds are closed.
It is thus probably a matter of time before neglected areas of the market get the coverage they deserve. “More capital doesn’t frighten me,” says Campbell. “There’s always room for new entrants. It keeps the market dynamic,” agrees Halford.