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We need to talk

Infrastructure investors find themselves in a healthy position looking forward. But the mistakes of the past mean a healthy debate about fund economics is necessary.

Within the alternative asset universe, infrastructure’s star is in the ascendant. As noted elsewhere in this issue, Damon Williams, head of institutional at Canada’s RBC Global Management, accompanied his firm’s launch of a new infrastructure investment team with the following pronouncement: “In terms of deciding our priorities, infrastructure was a higher priority than private equity at this point.”

There are sound reasons why infrastructure investors can justifiably feel bullish about prospects. The desperate need for zillions of [insert currency of choice] of infrastructure spending was clear long before the global economic and financial crisis came along. When it did, many governments saw splashing out on infrastructure as a central plank of the stimulus measures assembled in response. Given the now-parlous state of many nations’ public finances, much of the required capital for projects will need to come from private sources.

Meanwhile, continuing volatility on world markets means that limited partners see many reassuring traits in the infrastructure asset class – solid and steady returns, yield, inflation hedging and diversification among them. In conversations with market participants since the turn of the year, I’ve been struck by how many have confidently predicted a meaningful upturn in deal flow and fundraising activity in 2010. Despite the inevitable downturn in activity last year – as there was in pretty much any investment area you care to name – it does seem as if infrastructure has quickly come back into fashion.

This should not, however, translate into complacency. In recent years, many institutional investors have become aware of the possibility of putting significant amounts of capital to work with infrastructure fund managers. For some LPs, this has meant creating specific infrastructure allocations for the first time. And, unfortunately, much of this money was going into the burgeoning asset class at precisely the same time as some GPs decided it would be a good idea to view infrastructure investment in the same way as LBO investment by supporting projects with unsuitably large chunks of leverage.

Infrastructure is such a fledgling asset class and the terms of engagement between LP and GP are still in a state of flux

As a result, it’s not rare to find LPs licking their wounds following a disappointing introduction to infrastructure investment. Unsurprisingly, therefore, it’s also far from unusual to come across the occasional strongly-worded opinion on fund economics. Suffice to say, ‘2&20’ fee and carry terms are viewed – to put it politely – as having been an historic anomaly. The view of Michael Powell, head of alternatives at UK pension USS, seems fairly typical: “Our view is that infrastructure can't sustain 2&20 fee terms,” he told InfrastructureInvestor. “Too much leverage was used to try and get the return up to a level where the incentives were justified – and it didn’t work.”  And some LPs are increasingly sceptical that the ten-year fund life typical of private equity should be equally applicable to infrastructure.

This debate is highly significant, not least because infrastructure is such a fledgling asset class and the terms of engagement between LP and GP are still in a state of flux. It also comes against the background of radical thinking in the private equity real estate fund arena, where some LPs appear to be pushing for veto power over deals – thus challenging the very notion of the traditional limited partnership (see the February issue of our sister magazine Private Equity Real Estate for more on this).          

Some perspective is useful at this point. In a recent media breakfast hosted by Paris-based GP Antin Infrastructure Partners (see also p11), the firm’s chief executive Alain Rauscher pointed out that 1.5 percent fees remain typical of infrastructure funds – a 2 percent fee was never the norm. On life cycles, however, he insisted that 10- or 12-year timeframes were indeed appropriate as a way of maintaining the discipline of the fund manager. “Ten years from now, we [the managers] have a good idea where we’ll be. We have no idea about 20 or 25 years’ time. There’s an issue of accountability. Can investors trust that we will still be around and delivering value after 25 years?”

As an asset class, infrastructure has made – and continues to make – great strides. As it does so, it will need to find an investment model that works efficiently for both LP and GP. The ongoing debates are therefore vitally important – and healthy.