Secondaries: boom times ahead?

Trading stakes in infrastructure funds currently represents a tiny part of the secondaries market, with only around $1.6 billion traded in 2015, according to advisory Setter Capital. However, sources expect deal volume in the asset class to boom over the next two years. 

Market participants tell us there are at least six GP-led deals involving infrastructure funds currently in market.

One is Arcus Infrastructure Partners ' offer of an optional exit to LPs in its €2.2 billion fund. The London-based firm is seeking new LPs willing to support the fund in an extension and has so far secured a circa €400 million secondaries investment from Dutch pension manager APG , plus some €200 million from a group of other investors. It is set to attract a further €200 million by the end of April. 

The process is a prime example of an entire generation of pre-crisis infrastructure funds where LPs have divergent objectives and need some form of structured solution. In the process, a large portion of existing investors want ongoing exposure to the portfolio, while others want liquidity sooner, having changed their strategy on infrastructure investments since committing to the 2007-vintage fund. 

Sources tell us such deals are symptomatic of the problem with the infrastructure play, which generally involves longer time periods and returns from cash-yielding assets. Infrastructure assets don't necessarily fit cleanly into the 10-year private equity fund model, into which many infrastructure funds have been shoehorned.

“You have an infinite time horizon with infrastructure,” says a partner at a European fund of funds which is active in the infrastructure secondaries space. “You're supposed to buy a bridge for 100 years and that doesn't fit with everybody's model.”

But will all infrastructure fund managers face a similar issue with end of life funds, and is Arcus the tip of the iceberg? The answer, from most industry participants we speak to, is a resounding yes, although they all differed on how big the rise would be and when a boom was likely to happen.

Secondaries interest in the asset class is spreading across a wider section of buyers too – almost a fifth of secondaries market participants surveyed in Setter's report said they bought alternative investments, such as infrastructure, for the first time last year.

Buyers best positioned to benefit from these developments, we're told, are sophisticated pension funds, insurance firms and sovereign wealth funds. Such players have the in-house capability to price infrastructure portfolios due to being primary investors in the asset class, as well as the desire to hold infrastructure assets for long-term yields, even on a secondaries basis.

“They're actively looking for these types of opportunities to access income-yielding assets from day one,” James Bromley, a lawyer in Weil, Gotshal & Manges' private funds group, tells us.

One interesting development is the increase in LPs wanting a solution for end of fund life being written into limited partnership agreements (LPAs). Ed Gander, co-head of Weil's global private funds group in London, says LPs in infrastructure funds are becoming increasingly aware of potential issues at the end of a fund's life.

“Each year, the knowledge base of the larger LPs in relation to structured fund solutions is rising as they participate in increasing numbers of these types of transactions,” he says. “This makes it even more important for GPs to check that their fund documentation caters for the type of solution they would like to implement towards the end of the life of their funds.”

In Arcus' case, the fund's original LPA contained mechanics for the extension of the fund or liquidity solution, if supported by LPs. While this isn't common, it is increasing, according to lawyers who work on infrastructure fund restructurings.

Ultimately, any tool that helps remove potential delays or friction when it comes to end of fund life issues for infrastructure – no matter how small a part of the overall market –  will give LPs comfort from the get-go they can get liquidity, which can only be a good thing.