Doing it right

Q: In the core infrastructure segment you focus on, what areas are of greatest interest to you?

DH: We are very clear about what we mean – our core infrastructure strategy is centred on transportation, regulated utilities and energy infrastructure, including operating renewables such as onshore wind, solar and small hydro. Our transportation focus is on the lower risk end of the transportation spectrum, such as medium to larger airports and ports, which, while they may have some economic risk, we still think fall into our definition of core assets. In energy infrastructure, in addition to renewables, we will look at contracted storage, pipelines, district heating and grid management infrastructure, for example.

We are also interested in the UK rolling stock sector. In fact, our most recent transaction was in UK rolling stock. We are providing equity financing for Govia Thameslink Railway, to fund the replacement of its suburban train fleet on the Great Northern route, the first for new rolling stock company Rock Rail.

It is quite a groundbreaking deal, as it is the first time in the UK that a private sector procurement has been sourced out by the traditional rolling stock companies. That we were the exclusive equity provider made it a compelling proposition for us. In addition, there is a strong pipeline for such new procurements in the UK, so we can look to fund new trains. It is a deal we are proud of.

Q: How is the pipeline looking like in your target geographies?

JC: We are plugged into the information flows and see all relevant opportunities in our key markets, but importantly we are investing time in relationships to develop bilateral opportunities and partnerships with likeminded investors.

In terms of opportunities, we are seeing a lot of activity across our core sectors and geographies and certainly a lot of core dealflow. We spend a lot of time filtering out opportunities that we ultimately believe aren’t core or are going to be too competitive or where we don’t have some form of competitive edge.

As a generalist infrastructure fund, we are aiming to invest across a range of sectors and not concentrate our capital in any one risk, positioning ourselves to meet or exceed our return targets in all economic conditions. Based on the activity we are seeing, I am confident we will deploy our capital in a portfolio of high-quality core infrastructure investments.

DH: We focus exclusively on the UK, DACH [Germany, Austria, and Switzerland], Benelux, Ireland and the Nordic countries. That is really where we are targeted in terms of geography and we look at small to mid-cap transactions with enterprise values of up to €800 million.

Q: Why have you chosen to invest 50 percent of the fund in the UK and up to 50 percent in the other parts of Northern Europe you have mentioned?

DH: A number of reasons, actually. SL Capital is more broadly a Europe-focused business with a bulk of assets under management focused on this region, although the private equity team does have a capability in North America. In infrastructure, we took a call based on where we thought we had the best availability of dealflow, coupled with where we had a substantial footprint. Now, for instance, almost all of the infrastructure assets in the UK are privately held. The UK is also our domestic market, so it was always going to be our focus.

Separately, in the Nordic countries in particular, we have a footprint as we have been active there. We also have a cultural affinity to the Nordic countries and find it comfortable to do business there. We see very suitable dealflow emanating from these countries and so they are important for us. We also see a reasonable pipeline in the DACH countries. We are looking to make between six to eight investments and have made three already, with opportunities for follow on investments, so we only need three or four more.

Q: Are the recent macro developments in Finland a concern?

JC: We are invested in the regulated gas distribution sector in Finland through our investment in Aurora. While the economic environment in Finland has been challenging, we are happy with our investment. Gas is a core part of the energy infrastructure for our customers locally. It is an essential service fuel for many people for basic necessities such as heating and cooking and as such we viewed this as a solid opportunity. And so far, it has panned out that way for us.

When we made the investment in Aurora in June 2015, we believed that it was a business that would not be too adversely affected by the macro environment. The biggest driver for variations in volume is in fact the weather and in particular the temperature. However, the impacts are modest. Aside from heating and cooking, there is a significant industrial customer base whose consumption is not so correlated to temperature and for whom certain properties of gas – such as purity and convenience – are important to their industry.

What we also considered at the time of the investment when looking from the cost and distribution standpoint is the competitiveness of gas as a source of energy. Of course, for some, gas is the most cost effective form of energy and the economic environment notwithstanding, we are seeing a number of new large customers making enquiries about adopting gas as the fuel of choice for their businesses.

We also spent a lot of time speaking to our internal macro team before making the investment. Standard Life Investments manages a significant amount of capital exposed to different currencies and as part of the wider Standard Life group, we have in-house research that provided us with insights on understanding the macro situation in Finland. So yes, while the environment is a challenging one, so far our investment has not been adversely affected.

Q: Tell us a little bit about how you align interests with LPs and how that affects your fee structure?

DH: We don’t believe that private equity style investing is appropriate for long-term core infrastructure. That structure really motivates the manager to buy an asset, usually dress it up and then offload it – that is not something we think works for core infrastructure assets.

So we employ a twofold approach. First, our initial asset holding period is 12 years, which we can then extend in either five-year periods or start liquidating. The second is in terms of the fee structure – we decided to do away with carried interest incentives, so we are not motivated to buy and sell, but instead motivated to buy and hold.

The investors only pay when the money is invested and our fees are based on the net asset value of the projects. We’d like to think this is a novel idea that provides much better alignment between us and the investors. It has been very positively received by investors.

We think the structure is also quite innovative in terms of tenure, wherein it is a bit of a hybrid between a closed-ended and an open-ended fund. For these reasons, we think this product is unique in the market at the moment.

Q: Did prospective investors have concerns?

DH: One question we have been asked quite a lot, even with investors understanding why we don’t have carried interest, is whether our fee structure affects the motivation of our team, as it is an important part of the economics.

The answer to that is we have put in place an incentive plan (LTIP), a tool that ensures that the team lives with us for as long as the investment. The LTIP starts paying out to the team after four to five years and more return is accrued as the fund progresses. That keeps us motivated to stay with the fund for its duration.