Times are lean, and this has put many public pensions in the mood to head to the institutional-investment equivalent of Home Depot with regard to their new infrastructure allocations. In other words, these pensions want to do it themselves.
But as many frustrated Home Depot customers can tell you, it’s hard to build or even refurbish a house without the services of those who do this kind of thing on a regular basis.
Having built up sizeable private equity portfolios that are made up almost entirely of third-party funds, these pensions are rightly excited about starting fresh in infrastructure with a different approach. As they discussed at a closed-door meeting sponsored by Stanford University last month, major North American public pensions and several other large institutions globally are eager to avoid the classic 2-and-20 fee structure of the private equity asset class.
Many believe that the best way to avoid fee drag is to do much of the work investing in infrastructure themselves. An idea related to this might be called the “pension club”, whereby large institutions band together to pursue, buy and own assets. While these limited partners (LPs) are right to question fee orthodoxies, especially given the lower return profile of infrastructure assets, they should absolutely put professional, third-party infrastructure investors to work in building out their allocations.
There are many reasons why it makes sense to use specialised managers in the infrastructure asset class. Here are a few:
• Infrastructure investing is very resource-intensive – While at first glance, owning, say, a toll road, may not seem much more complicated than pairing a brownfield asset with a competent operator, actually getting to that point is a years-long process fraught with technical and political complexities that few pensions are equipped to navigate. Paying an expert to have these headaches on your behalf can yield superior results, even factoring in fees. In fact, placement agent Probitas Partners recently reported that the cost of hiring staff and bringing other resources in house roughly equals a 1.5 percent management fee, anyway. And remember, too, that pursuing infrastructure assets involves many failed bids, which can be very expensive and hard to budget for.
• Pension paths do diverge – Public pensions often want to own their infrastructure assets for many, many years, and yet during that span of time, different public pensions will have different liquidity, tax and other needs that may put them at odds with other “club” members. A competent third-party manager is best positioned to structure an investment vehicle that resolves divergent interests as they pop up.
• Professional managers provide political cover – Especially in the US, public pensions are already subject to distracting political influences. A hired fiduciary can help defray these influences. While it makes for great politics to propose that a public asset be beneficially owned by the local pension plan, it glosses over the fact that the seller requires a high price and the buyer a low one. Better that a professional asset manager be accused of driving a hard bargain. Furthermore, a manager with a diverse client base will also be able better withstand political demands that local pension money be concentrated on local projects. A manager should unapologetically put local pension capital to work wherever the best opportunities are, often in concert with pension capital from other regions or countries.
While Wall Street firms will no doubt be cheered to confirm that they are not expendable in the infrastructure asset class, the LP-friendly news is that dreaded private equity-style fees are under tremendous pressure in the infrastructure world. It is too soon to declare the demise of 2-and-20 in infrastructure, but enough credible general partners have offered compelling (read, cheaper) alternatives to this that one can say confidently that this bold new asset class will indeed develop a set of market norms that are appropriate to its particular characteristics.
In the meantime, pensions should be warned that the proverbial trip to Home Depot may be the beginning of one hell of a home-improvement project.
Contractors await your call.