Strategy drift is a tricky concept. Broadly speaking, it conjures images of managers behaving badly and not doing what they said they should do, but get down to the specifics and things are rarely that clean cut.
For instance, are managers accused of strategy drift actually doing something that goes against their LPAs? And do all LPs in a fund agree their manager is drifting? Even when they do, it might not matter much from a legal standpoint.
That was certainly the lesson imparted in 2012 by London’s High Court, which ruled against 22 angry LPs suing Henderson for breach of mandate. The LPs contended they invested in Henderson PFI II on the basis that it would invest in low-risk PFI assets. Instead, Henderson turned around and used that fund to buy John Laing, a fully fledged PFI developer with several lines of business and a pension deficit. As a result, the fund, at its lowest point, was worth 30 percent less than the £573.5 million it had raised and was generating an IRR of minus 8 percent.
The court, however, was unmoved: once LPs put money into a fund, their role is mostly passive; that’s the trade-off they get for enhanced protection should disaster strike. Of course, that doesn’t prevent LPs from voting with their wallets, but it does underline how tricky it is to actually agree on what constitutes strategy drift.
Lately, though, we’ve been hearing LPs express concerns about managers at the lower end of the risk spectrum. Specifically, about managers who have traditionally made a living investing in PPP/PFI assets branching out into other ‘low-risk’ corners of the infrastructure universe, such as renewables and the non-PPP segments of core infrastructure.
The concerns seem to be twofold: firstly, that they mostly invested in these managers to get exposure to PPP/PFI assets (though given the dearth of deals in the space, one has to wonder what they were thinking); and secondly, they wonder whether these managers have the skills to invest and manage these new assets they are piling into.
The second concern is the most interesting of the two. For example, is a renewable asset backed by tariffs as low-risk as an availability-based PPP considering that governments across Europe have imposed retroactive tariff cuts on renewables? And what about power price exposure, considering that, at the moment and contrary to most forecasts, prices refuse to go up?
Risk profile aside, LPs are also worried about whether these managers are investing in the right way. One LP, referring to a recent high-profile transaction in the core infrastructure space, expressed concern the manager had bid on too low a return. Worse, that modest return already factored in more leverage than the LP would have liked to see. Seeing as PPP assets are usually heavily leveraged, the LP wondered if this was a case of the manager carrying over some old habits.
The real question for us, though, is not so much whether there’s a risk these PPP/PFI managers will fall on their faces as they branch out into new sectors. Rather, it’s how much value can they realistically add compared with managers who have already been investing in these sectors for much longer? Managers who, in many cases, have spent years building up their teams with the required expertise.
In that sense, the issue of strategy drift becomes less about the strategy changes themselves and more about how far managers are willing to go to back those changes up.