Victory for the big guy

Tiered fees are a clear example of infrastructure funds’ prioritisation of those prepared to write large cheques

Those raising infrastructure funds are thinking ‘big’. That is, they want big investors committing big tickets. And, if that involves a little humility when it comes to fund economics, then so be it. 

Infrastructure Investor was recently shown a real-life example of a tiered management fee structure (firm and currency denomination were unidentified). Here’s the breakdown: Less than 75 million [units], 1.75 percent management fee; 75 million to 150 million, 1.5 percent; 150 million to 225 million, 1.25 percent; more than 225 million, 1 percent. 

This kind of structure, so we’re led to believe, is far from being unusual. Sources say tiered fees (and tiered carried interest as well) have become so common a feature of infrastructure funds that they are almost market standard.   

While the private equity asset class has also seen similar tiering, it does not tend to be advertised quite so openly. In infrastructure funds, the tiering will often be explicit in ‘main fund’ documentation. In private equity funds, the lucky co-investor will happen to find that their terms and conditions in the separate co-investment vehicle are more favourable than those in the main fund. Same outcome, subtle difference in approach. 

So why this unabashed flaunting of discounts to those with the fattest wallets? Partly, it has to do with infrastructure fund managers’ fear of being sidelined by the largest investors choosing to invest in infrastructure directly. (Private equity managers have always talked about direct investing being restricted to a small group of LPs; their infrastructure equivalents say the same thing but with less conviction as they see more and more institutions testing the water). Fee and carry reductions are an obvious way of seeking to keep investors with a ‘take-it-or-leave-it’ attitude within the fold. 

Also, many fundraisers in recent years have gone out with a ‘whole market’ approach, embracing all types and size of investor…only to find the fundraising ends up treading water. According to sources, momentum early in the process is now seen as crucial. Hence, general partners (GPs) are identifying a shortlist of existing and new investors (the common thread is that they are large investors) and throwing all their efforts into achieving a first close – by which point, it is hoped that at least 50 percent of the fund’s final target will have been raised. 

One source also mentioned a historical aspect, which is interesting though less easy to substantiate. Namely, private equity started small and gradually evolved to the point where very large investors began to emerge. The infrastructure asset class, by contrast, is growing up more quickly in a market where the presence of the very large investor is well established. The theory is that infrastructure, unlike private equity, does not have the smaller investor etched into its DNA. 

Smaller investors are quick to point out that this bias to the big beasts could backfire. What if they have a change of heart – either towards infrastructure investment broadly, or towards investing in it through funds? They could, in other words, prove fickle partners. In such an eventuality, smaller investors may rightly view GPs’ attempts to begin courting them as somewhat cynical. 

Of course, GPs may well argue that all of this paints a false picture – that they are, in fact, utterly non-discriminating. And it’s true, of course, that the observation of a trend also carries with it the risk of generalisation. But perhaps a more compelling defence of GPs’ bias to larger investors comes from a surprising source. One investor at a small endowment confided to us: “I’m very unhappy about the situation. But, you know what, if I was in their position, I’d be doing exactly the same.” 

*To find out more about developments in infrastructure fund formation – including a survey of more than 50 limited partners – be sure to check out the cover story in the February 2012 issue of Infrastructure Investor