A fork in the road

There was a time when financial engineering pretty much overshadowed asset management. Yet listen to fund managers these days and they will tell you that the golden age of financial engineering is well and truly over. “The days when you could do deals by being a financial genius are long gone,” argues Mikael Karlsson, co-head of energy at emerging market firm Actis.

But are they? “There tends to be a greater tendency to focus on financial modelling, with people sitting behind laptops, focusing more on banker and investor demands than what an asset needs. Bidding for assets has become a capital shoot-out,” notes David Russell, chief executive of Singapore-based Equis.

Given how core infrastructure valuations have skyrocketed lately, Russell’s point carries the ring of truth. But you will be hard pressed to hear it from the horse’s mouth and trying to find investment firms that specialise in financial engineering these days is like looking for managers that trumpet their appetite for overpriced assets.

Instead, the limelight is now on active asset management, which is perhaps only fitting, since managing assets is what gives asset managers their name. Recently, thought, the concept has taken on fresh urgency: with asset scarcity and rising prices making it harder to find bargains, firms see the need to work harder post-acquisition to achieve returns. Or they seek more complicated transactions from the outset, in which case considerable effort is also needed to iron out post-acquisition issues.

Serious asset management, most industry players will tell you, is “part of our DNA”, a “key differentiator”, something “we’ve been doing from the outset”. But while it is hard to find an asset manager that will readily admit to having switched strategies, an evolution is indeed noticable: “Ten years ago my thought process on asset management was lighter than it is today”, one fund manager tells us.

It is not only a matter of experience. Nor is it just the result of increasing pressure on returns, according to Bruno Candès, a partner at Paris-based InfraVia. “The market has bifurcated between core infrastructure and value-added strategies. This is forcing managers to ask themselves a number of questions as to how they can create value through asset management.”

With that in mind, perhaps the most pertinent question to emerge is: what is the job of today’s asset managers really all about?

BACK TO BASICS

Trying to define asset management is like trying to define infrastructure. When asked what the concept means, the fund managers we canvassed either came up with all-encompassing definitions or a checklist of qualifying items – or both.

Let’s start with the definitions. “Asset management is about preserving the value of the investment we have in our portfolio of projects,” says Stewart Orrell, head of asset management at InfraRed. “Everything that can impact the value of your business should be part of asset management,” argues Russell. “In the context of buy-and-build strategies, asset management is what you need to do to get a company to be best in class in managing the underlying assets,” adds Karlsson.

Three themes can be fleshed out from this sample of answers: risk management, value creation and the idea of knowledge sharing and best practices. The first, Candès says, is the traditional tenet of infrastructure asset management. “It’s a tool of monitoring, used to control risks in the operational, financial and regulatory sphere. When we were buying wind farms through our first fund, for instance, asset management was essentially about managing risk and operations, cost controlling and reporting.”

That, obviously, has not disappeared. In fact it remains the main plank of core infrastructure strategies – even at the more active end of the scale. “A lot of our investments are highly structured PPPs. The nature of these is set out in great detail at the outset in contracts, so what we are doing is managing those contracts,” says Orrell. He adds that opportunities for value creation are “relatively small”, but there are lots of them. “So it’s doing what you can at a small scale, but multiplied by many different things.”

Indeed, not every asset offers much margin for improvement, which means the idea that transformative asset management should be the modus operandi of every firm does not really stack up, Candès observes. “Take a wind turbine. You make money when the wind blows, if it doesn’t you don’t. Putting three Nobel Prizes below it to think about it is not going to make it spin.”

THE SHARING ECONOMY

Having said that, it is undeniable that another strand of asset management has recently gained momentum, with a variety of approaches now geared towards generating higher returns by venturing beyond risk control and incremental improvements. “It’s almost private equity applied to infrastructure. It’s going after value you can produce beyond a regulated or contracted return,” Candès says.

That, of course, is easier when you control a company. “If you own 3 percent of a water business in the UK, your ability to create value is marginal. But if you bring 70 percent of the capital to a company that was either captive to a big industrial group or owned by a clutch of small shareholders, then your equity can help transform the business from the top,” he explains.

In those types of situations, there’s a whole gamut of improvements a fund manager’s ownership can help engineer, including consolidating a platform through acquisitions, streamlining cashflows, optimising the capital structure and re-incentivising the management team, to name just a few.

Active asset management is even more natural when you are building businesses and especially when you are focused on greenfield infrastructure. “When you develop and build an asset from scratch there’s a greater appreciation of the fundamentals and importance of asset management,” says Russell. That does not mean his company necessarily prefers complex assets. In fact, Equis is mostly focused on wind and solar assets. “Our preferred approach is ‘Keep it simple, stupid’ – we don’t like risk and unnecessarily increasing the likelihood of different outcomes for otherwise stable assets,” he notes.

One aspect Actis’ Karlsson insists on is the human dimension of asset management. What he calls “industrial management” is supposed to be part of the day job of Actis’ top executives, who mostly come from the world of power producers and utilities. But that is only one dimension. “Finding the right management team to lead your business is a key challenge. The best skillset for running a Cameroonian utility business is not necessarily in Cameroon,” Karlsson points out.

Concrete incentives also help. Russell explains that every top executive at Equis’ portfolio companies holds an equity stake in the business they help run. But so does storing information and sharing best practice across portfolio companies, through initiatives such as off-site days, regular conference calls and cloud-based information systems. “I don’t think it’s enough to have one guy in a fund calling himself Mr Operations. It has to be in all the people,” Karlsson adds.

And that, in a nutshell, is where asset management seems to be headed. There was a time when you could claim to be an asset management expert by just naming a few operational partners. But like the heyday of financial engineering, those days seem to be increasingly in the past as well.