Infrastructure Investor’s “Week in Review” of 17 December 2015 had a merry headline: “Infra managers’ ongoing existential crisis.”
The feature explores decisions by the California Public Employees' Retirement System (CalPERS) and others to invest in infrastructure using separate accounts as the preferred way of investing in this asset class. It concludes with the observation that two of the largest infrastructure funds (Global Infrastructure Partners and Brookfield Asset Management) will book $27 billion for their new funds in 2016.
Hence the conundrum for many institutional investors: they want to increase allocations to this asset class, but the vast majority of the opportunities to do so come as invitations to be limited partners (LPs) in the same old fund structures. The problem with those structures, CalPERS and others have found, is difficulty in tracking (and therefore justifying) the amount paid to fund managers.
The funds have responded by devising a variety of variations such as co-investment programmes to create the appearance of direct investment. Even so, the deal flow still originates with the fund. Most funds have a strong bias in favor of quick results, so they prefer to engage in buying existing infrastructure assets. The vast majority of infrastructure deals, therefore, are in secondary markets, and the return to LPs is ultimately determined more by the acumen of the general partners (GPs) as “infrastructure traders.” In this cycle, so far, nothing has gotten built: it’s all about buying and selling existing stuff.
The few Funds that are willing to build new infrastructure facilities must find the developers who can actually get things started, permitted and built. For developers, therefore, the funds are a means of access to capital, but it comes at a cost. Naturally, the question arises, why shouldn’t the developer and the LPs deal with each other directly?
It seems that the simplest way to break the existential crisis (and with a tumbling stock market, crisis seems to be an apt word) is for institutional investors to invest directly in infrastructure asset development and take responsibility for monitoring and managing that investment. That’s not easy to do when your minimum check size is $200 million and your biggest problem is recruiting and retaining talented staff.
One solution to the problem is platform companies. To a private equity firm, a platform company is the initial entity the firm acquires in an industry, which then becomes the foundation for other acquisitions in that industry. In an M&A-oriented discussion, this makes sense. But M&A should not be the only business a platform company is in. There’s much more value-add in development. Most infrastructure acquisition opportunities take place in organised auctions, and when the sector is “hot” (as infrastructure is now), prices are likely to be high and yields correspondingly low.
The platform company can add more value if it’s primarily in the development business, creating viable projects from scratch. In the electric infrastructure arena, for example, projects that are designed from scratch target internal rates of return between 10 and 20 percent and a long string of steady returns, sometimes lasting decades because the underlying asset is so durable.
Nothing valuable is easy, so the institutional investor that decides to pursue these higher infrastructure returns must do something that it has traditionally eschewed: development risk. As Stanford Professor Ashby Monk has noted, however, platform companies can be “access points” to the private capital markets where most infrastructure is incubated, developed, financed and built.
Monk argued in a recent article, A New Approach to Pricing Market Access, that “it's important we get this private market access point right, as most pension funds continue to see privates as a critical part of meeting their lofty return expectations… [F]or private investments to deliver, investors are going to have to unpack the access points and really figure out how to maximise investment returns.”
Platform companies are indeed access points, and some of them are eager to help institutional investors get better returns from infrastructure investment. But the quid pro quo is simple: the platform companies need to be able to access the institutional investors for development capital, in order to give them access to the better returns that typically go to the early investor.