The emergence of mid-market muscle

An elite of larger funds have dominated the fundraising landscape, but are investors now beginning to shift to the neglected middle?

The numbers are in, and they point to a possible record year. The Infrastructure Investor Research & Analytics fundraising report for the first half of 2015 shows the global infrastructure fundraising total was more than $21 billion in the first six months – the best result ever recorded, with 33 funds contributing.

But is this a new dawn, or more of the same? There are plenty of asset class observers who would argue that while a small selection of established funds with a solid track record are capable of raising ever larger pools of capital, the majority of players find fundraising something of an uphill struggle. Does a burgeoning fundraising total merely reflect the increasing dominance and pulling power of an asset class elite?

Our own report certainly points to some brand names and established fund managers among the largest capital gatherers in the first half, with Blackstone (for its Energy Partners II fund) and First State (for its European Diversified Infrastructure Fund) among the six managers which closed funds on or above $1 billion during the period. However, I Squared Capital’s debut fund – ISQ Global Infrastructure – closed on $3 billion, with appetite reportedly well in excess of the hard cap. So what can we make of that?

The recent Global Alternatives Survey 2015 by Towers Watson and the Financial Times hints at the appeal of infrastructure funds extending more broadly than many would assume. It is frequently suggested that the future of infrastructure investment lies in direct and co-investments as ways are sought to lower costs. However, the survey found the following:

“While there remains a trend for greater co-investment and direct deals from investors, the very largest investors in the asset class are actually reversing this trend and starting to again re-engage with traditional asset managers to assist in asset execution (both origination and asset management).”

There is a qualification, though. While investors are seeking the assistance of fund managers with origination and asset management, they are not wholeheartedly embracing traditional fund structures. Many of them are instead opting for segregated accounts in order to tap areas of the market that they would struggle to access without professional expertise.

Equally, the survey challenges the assumption that the roost is ruled by a small and select band of favoured managers capable of raising multiple billions. Such funds do of course exist, but what the survey detects is a growing shift towards the embrace of mid-market funds.

If true, this would be a significant development. Views differ as to why, but infrastructure has not yet developed a large and thriving group of mid-market managers in the way that other asset classes such as private equity have. A surge of capital could help to redress the balance and encourage more activity in a part of the market where there is not the supply/demand imbalance that many claim is evident at the larger end.

But even this welcome development would not come without additional concerns, according to the survey. For one thing, it says, the mid-market itself could quickly become crowded. While it’s quite possible that capital could be channelled into the mid-market at a steady and viable rate, it’s also not inconceivable that investors may get a little, shall we say, over-enthusiastic.

The survey also contends that investors – especially in larger mid-market funds – may expect co-investment opportunities that will not be forthcoming. This will “lead to either disappointment of the level of co-investment offered…or asset managers potentially have to migrate towards larger investment opportunities”.

Therefore, while the future for infrastructure’s mid-market looks encouraging, it should certainly not be taken for granted.