Too hard a bargain

Should investors be so eager to apply thumb-screws to GPs on fund economics?

Dutch infrastructure fund manager DIF has a view of the fundraising market that might be described as pragmatic – which some may argue is the Dutch view of most things. Today, we exclusively reveal that the firm is knocking on investors’ doors for its third fund, which is aiming to raise €600 million.

DIF managing partner Wim Blaase was last week part of our European Fund Management Roundtable in London (a full summary of which you will find in the December/January issue of Infrastructure Investor). There he said: “We see that it’s a challenging market. It’s similar to post [2008] Crisis. Some LPs might be positive but then there might be a cut in their infrastructure allocation. So you have to adapt. Track record is even more of an issue than it’s ever been.”

DIF is arguably in a better position than most. With two funds already under its belt (a decent track record for an infrastructure focused-fund manager), its second vehicle closed on €571 million in September 2010 – beating a target of €500 million after 20 months of fundraising at a time when conditions were not materially more favourable than they are now. 

But, generally speaking, times are tough for fundraisers – we’ve heard enough anecdotes from GPs and placement agents to know that even those with plenty to boast about are facing tough negotiations on fees and carried interest from at least some of their investor base. 

At this point you may be thinking: “Isn’t that only what you’d expect?” After being confronted with strong upward pressure on fees and carry during the boom years, when GPs could pick and choose which LPs to allow into their funds, who can blame LPs for now seeking to turn the tables?      
The instinctive response is that few would apportion blame for this. But at the same roundtable discussion, the view was forcefully expressed that you simply can’t adequately resource an infrastructure fund management business – both in terms of the number of staff and the credibility of those staff – when fees are being whittled down to next-to-nothing levels by some particularly aggressive LPs. GPs will say – contrary to what LPs and others may believe (or once have believed) – infrastructure is an asset management business. Don’t underestimate what that costs. 

One roundtable participant referred to the “fight for fees”. This may not quite carry the same weight as a “fight for education” or “fight for jobs”, but there’s a serious point. Unwilling to accept fees that simply don’t appear to make economic sense, some of those on the fundraising trail may not be able to raise enough capital from those offering terms that do make sense to them – and quietly depart the scene. The number of infrastructure fund managers – already a very small number compared with the private equity equivalent – may be greatly reduced.   

In a recent discussion, a leading infrastructure advisory professional expressed the view that the total number of infrastructure-dedicated fund managers in the UK could dwindle from around 50 to 15. The same source also expressed the opinion – one which would no doubt gladden the hearts of George Osborne and Lord Sassoon – that institutional direct investors will come to the party in a big way. As a result of which, the source expected the quantum of capital available for infrastructure investment to increase rather than decrease. 

But this will not happen overnight. Explore the reasons why and you’ll discover an irony. It will take a long time for pension funds to build up the sufficient resource that’s necessary to invest large sums in infrastructure. It’s a matter of building teams of credible people and paying them well. This is precisely what the Australians and Canadians have done, and why they dominate the playing field. 

In pondering this, pensions everywhere might come to a true appreciation of the cost of building and running a high quality infrastructure investment business. If they want funds to survive and prosper – whether primarily as an originator of deals in which they can co-invest, or as a useful learning experience on the path to eventually going head-to-head for direct investments – they may be well advised not to drive too hard a bargain.