Infrastructure has long been a favourite topic of macroeconomists, who’ve long seen it as a crucial plank of any policy designed to boost growth and productivity. As we are often reminded through reports and speeches, this is even truer today: new roads and railways are required to relieve bottlenecks in emerging countries, while transport and broadband schemes are seen as key to fortifying the developed world’s recovery.
But microeconomics – the study of how supply matches up with demand – is just as useful to analyse the asset class itself. And in the current context, its diagnostic seems as hard to argue with as it is simple to formulate: the market still has some way to go before reaching its equilibrium. “The volume of capital willing to access the asset class far outweighs the number of fund managers able to welcome it,” says Bruce Chapman, a partner at London-headquartered placement agent Threadmark.
The sustained growth in demand, at times when interest rates remain at rock-bottom in much of the developed world, is easy enough to explain. Still a nascent asset class in many respects, it is fast becoming known among institutional investors of all sizes as a relatively safe solution to match liabilities with recurrent, long-term yield.
More puzzling is why supply is seemingly reacting with so much delay. It’s not that existing fund managers are not surfing the trend: as Chapman notes, a number of incumbent firms have recently raised bigger vehicles at a record pace. But this increase in size alone is not enough to absorb the hungry capital out there, he says. “The number of fund managers is not increasing; if anything it probably has slightly decreased. Significant pent-up demand has not yet found a home.”
Noticing the queue of would-be buyers of core infrastructure assets sold at auction – and the prices these are often fetching these days – could lead one to doubt this assessment.
But this would be ignoring the fact that high-profile transactions only represent a fraction of the market. As Threadmark senior vice president Andrew Harris contends, the relative scarcity of newly established fund managers is leaving some areas rather sparsely covered. “There are particular strategies and geographies within infrastructure where competitive dynamics are not particularly robust.”
Among the neglected areas, Chapman elaborates, is the opportunistic end of infrastructure. “Very few managers have raised capital to create infrastructure products that core funds can then invest into. It’s a very thin universe, and one that is even thinner than it was.” One exception to this is the US energy sector, which Harris reckons has seen “exponential growth” in recent years. But appetite for opportunistic strategies beyond the energy space remains little catered for, he concurs.
The growth of established players is also leaving the lower to mid-cap end of the market increasingly deserted. The renewables sector, which can boast a wider selection of smaller managers, probably provides a counter-example. But with some follow-on vehicles now about twice the size of their predecessors, Chapman says a vacuum is appearing in other areas.
This comes at a time when investors themselves are growing ever more diverse in their demands and expectations. In the UK, for instance, local government and corporate pension schemes tend to view infrastructure investments as part of the asset-liability matching exercise, and as such tend to focus on the lower-return, lower-risk end of the spectrum.
Chapman reckons the picture is different in the Nordics, where investors have evolved from a cold start in the mid-2000s to become owners of relatively mature portfolios. “They would selectively add new managers to it only if and when there is a particular niche they want to cover or as a way to rebalance their portfolio.”
RIPE FOR INNOVATION
Germany is again an altogether different market, where the appetite of insurance and pension funds looking to replace bond exposure is putting fresh impetus behind public-private partnerships (PPPs) and renewables.
Although less fragmented from a political and regulatory point of view, Harris says the North American limited partner (LP) universe is similarly divided. Canadian investors, which have been exposed to the asset class for well over a decade, have since made strides towards investing directly; in the US, some family offices, endowments and foundations have a particular focus on opportunistic, higher returning strategies.”
New entrants, Chapman contends, would allow for a better representation of these diverse experiences, objectives and points of view. This is even truer in a context where fund products are somewhat back in vogue.
“Over the last five years a number of institutions have tried to go direct. But now a number of investors have come close to full circle, and are moving towards a model where they do fund investments again.” There are strategic reasons to this: some simply want to enhance the flow of deals they can access. But others have also recognised that they don’t have the budget to build a big enough team to manage a big portfolio of direct investments in-house.
The good news, he adds, is that there’s plenty of talent available out there: decades of experience currently in the hands of professionals serving as advisers or within international construction groups could be harnessed through setting up first-time funds. “These people simply haven’t had the opportunity to manage capital in fund format.”
He cautions that experience of the sector alone is not enough to guarantee a team will be good at spotting investment opportunities – let alone act as long-term fiduciary for institutional money. But that’s where external help from fundraising specialists comes in.
“In the mainstream private equity space first-time funds are seen as toxic by most placement agents,” says Chapman. “But here we thrive on them. The value-added we bring to bear comes far in advance of dusting off an old private placement memorandum and launching a known quantity in the market.”
Part of the job will be to make sure that the intentions of a new team are aligned with those of its prospective investors. A solid understanding of the process and timeline involved will be another key box to tick. “There sometimes exists a misperception about how easy it is to raise capital from institutional investors, and as such unrealistic expectations about timing,” Chapman says.
Yet he reckons external advice can be most useful when refining the strategy underpinning a novel fund product – so as to make sure it is likely to gather enough investor following. “Sometimes the new team will have a very broad skill set and an impressive track record. So we often work to help them synthetise their strategy in a digestible format for investors so that it is neither too broad nor too narrow.”
Often the team itself will have to expand. Top executives coming from large organisations will usually manage to put together a strong senior bench to raise capital, but their credibility will depend in equal measure on their ability to execute – and, as such, on finding junior recruits capable of handling middle and back office functions.
Challenges also arise for new infrastructure units within large organisations. “In such situations our role will be to educate the parent group on what is implied by raising a fund – while making sure the new venture will be managed on an independent basis, with a properly incentivised team,” Chapman says.
In all these situations, the existence of a seed portfolio will provide a significant head-start. This is especially the case in a context where fund managers are finding it hard to quickly deploy money: just like secondaries, pre-existing assets can bring investors immediate yield and improve real IRRs. Yet for such a strength not to turn into a weakness, Harris notes the exercise must be finely calibrated: too big a seed portfolio to take down in one go can make it daunting to reach a first close.
Helping the market nurture green shoots is no easy endeavour. Yet, as Harris notes, infrastructure is unique among private market asset classes in having demand outstripping supply. Importantly, Chapman says, the number of managers is one of the factors limiting deal flow – rather than the other way around – meaning that the arrival of new fund managers would likely help unlock a fresh wave of opportunities.
“It’s an ecosystem that feeds off its various elements, with a symbiotic relationship between its participants. Owners may find innovative options to divest assets once there’s a sufficient number of new entrants.”