Infrastructure demand is outpacing supply in the US right now, leading some to fear price increases for deals that are available. The four participants at our recent US roundtable all indicated that mid-to-high, single-digit returns are what is expected for core infrastructure assets. But the hunt for deals may be leading some fund managers to riskier terrain.
“Prices you’re now seeing paid for core infrastructure assets still represent reasonable value when you benchmark those assets against other asset classes,” said Threadmark co-founder Bruce Chapman. “The bigger problem is where, either through lack of sophistication or just through greed or lack of opportunity, people end up paying aggressive prices for the wrong kind of asset.”
For Paul Shantic, director of a $2.7 billion inflation-sensitive portfolio at the California State Teachers’ Retirement System, it is fund managers hedging on merchant risk that scares him the most.
“Managers wanting to put capital out and looking for projects and going: ‘Well, you know, I may get 60 percent of my capital back, but I think I can take this merchant risk for the next few years’ – that’s the kind of wishful thinking that scares me and that we focus on when we talk to our managers.”
According to Mark Weisdorf, managing partner of Weisdorf Associates, infrastructure price increases are part of the “normal course” of market conditions. He pointed out that infrastructure as an asset class has been around long enough to have experienced several economic cycles.
“Returns in the current environment are going to be lower than in 2009 or 2010. These things do go in cycles: economic conditions evolve; interest rates change; supply and demand of projects and financing evolves.”
Value-add investors are somewhat insulated from this competition. George Theodoropoulos, managing partner at Fengate Real Asset Investments, argued managers like Fengate seek higher returns by building an asset up, not hunting for deals.
“We’ve become value-focused investors in core assets. Our downside case would be 7.5 percent on an asset, which is not a bad day, but it’s not how we add value for our investors. I’m going to find something that’s going to give me 7.5 percent but then I find a path to getting it to well above market returns to make it worth our investors’ while and my while. These are strategies. We had to evolve there,” he explained.
A potential balm for investors focused on core infrastructure may be the open-ended fund structure, which has experienced something of a resurgence of late. A handful of firms have established successful investment vehicles that hold assets indefinitely, charging lower fees to LPs along the way. But whether a wide pool of investors are ready to commit to these structures is another story.
The time for open-ended funds will come, Chapman argued, but it will look slightly different from the vehicles we see today. “If you look at what core funds look like in real estate, I think that model will eventually feed into our space,” he said.
“What we haven’t yet done as a market is get comfortable with the current group of managers managing evergreen, open-ended vehicles. I think it will come.”
Weisdorf countered that “traditional open-ended managers, those launched in the 1990s or the last decade, are growing”.
However, Shantic, the only LP around the table, was concerned whether fund managers will stay focused on core infrastructure using a long-duration strategy, especially when those deals are hard to find.
“Does that core manager drift over time? Core becomes defined as something a little bit different,” he warned.
To read the full version of our US roundtable, please download our US Report 2017.