It’s not usual to hear an audible gasp from the audience when something surprising or shocking is unveiled in public. But it’s usually the stuff of magic shows or comedy acts, not . . . infrastructure conferences?
At this year’s Infrastructure Investor: Europe 2010 one could indeed hear a collective “ooh” as an audience poll was taken showing that the conferees had changed their minds on whether the private equity model works for infrastructure or needs to be replaced by something substantially different.
It was just one of the many timely reminders of the various trends shaping this rapidly evolving asset class. Here, in no particular order, are our top ten, based on insights shared at the event.
Private equity model is not yet dead. And it may not be for a while, since there are some salient features of it that work well for infrastructure – most notably, having your team be incentivised over the short-to-medium term. After all, if people aren't compensated for their work for 10, 12, 13 or 15 years, where's the incentive to not go to another shop if a better opportunity with more frequent bonus pay arises? These were undoubtedly some of the issues that went through the audience members’ minds as they voted whether the private equity model has failed for infrastructure and needs to be replaced with something substantially different. Going in to the debate, 56 percent agreed, 44 percent disagreed. After the debate? A 51 percent to 49 percent victory for the private equity model. The debate will undoubtedly go on.
Co-investing: lots of talk, little walk. LPs are very keen to get close to the action. One obvious way is through co-investing – the appetite is unquestionable and (for many) unquenched. But will this thirst ever be slaked? Alain Rauscher, head of Paris-based fund manager Antin Infrastructure Partners, said that “only a tiny fraction” of investors are “able to deliver”. He noted the many obstacles that stand in the way: governance, human resource, constitutional issues and the need for rapid decision-making among them. Have these requirements perhaps been underestimated? The same scepticism was expressed with regard to direct investing: it's a serious undertaking that requires a serious resource. For many LPs, planned participation may entail a lot of talk but little walk for some time.
Think more than just jobs. Job creation has been at the top of the agenda in many countries as a reason to get pensions to invest in infrastructure. But perhaps too much emphasis is being placed on job creation. “If that's all you want to do, you could build pyramids,” said Richard Little, director of the Keston Institute for Public Finance and Infrastructure at the University of Southern California. Little's right: there has to be a greater incentive for infrastructure investing than just creating jobs – otherwise, the pensions have every reason to sit out the opportunity. “We can't invest in infrastructure just because it's good for the economy,” said Robbert Coomans, advisor to the board of APG Asset management, the €240 billion Dutch pension.
It's the inflation, stupid. APG's Coomans also offered a timely reminder of why pension funds invest in infrastructure. Stable, long-term cash-flows are what pensions need to combat liabilities like inflation. It's this, more than a project's internal rate of return that will satisfy them. And if you need further proof of just how important the issue is, consider Coomans' following statement: “maybe performance fees should start being paid against them [cash-flows].” And, important as inflation is to infrastructure investing, it may only become more so. Henning Eckermann, the chief economist of Partners Group, warned of a spike in inflation in developed markets in the near future.
The economy is relevant, after all. Apparently, there's no such thing as a free lunch. When some infrastructure investors began pumping leverage into projects as a way of generating high-teens returns and justifying quasi-private equity fees, it almost seemed like a safe bet. Even in the event of an economic downturn, it was thought that the likely impact would be manageable. And why was this not a reasonable assumption? In the past, the correlation between infrastructure and the economic cycle was limited – you'd see a small deterioration for around six months and then everything would be back to normal. Not this time. The “GFC” was no normal downturn – and it didn't have a normal impact. Toll roads saw huge declines in traffic more or less overnight. Ports and airports suffered heavily as well. So views on infrastructure's GDP linkage deserve re-evaluation.
Take advantage of the debt markets now. But even those who pumped leverage into projects and lived to tell about it are not out of trouble yet. Bankers see a wave of over-leveraged infrastructure asset refinancings up ahead – and this means there are bound to be some “difficult discussions” between bankers and borrowers, said Chris O’Gorman, the head of infrastructure at Mizuho Corporate Bank. “The banks are just going to insist on that leverage coming down,” he added. So if you were thinking of talking to your bankers about taking out that new loan or refinancing one of your assets, now may be a good time to do so before the next wave of refinancing sours their appetite. A silver lining: there will be a requirement for new equity to help bring the leverage down, so opportunities for recapitalisations of the Brookfield-Babcock variety are bound to continue for some time.
Ignore Build America Bonds at your own peril. The US market is beginning to realise that regulations for this new type of municipal security are written so broadly that there is room for a lot of creative structuring – and private equity firms and investment banks are going to be taking full advantage of it. Here's just one manager, Peter Luchetti of Table Rock Capital, talking about how infrastructure funds can structure a BAB deal: “What happens is your equity goes in as sub debt . . . and if it's done in a concession format, there's no FIRPTA [Foreign Investment in Real Property Tax Act] implication. So it's extremely powerful. And it's just getting started in the US.” Others are noticing this too: a sovereign wealth fund investor in the audience said he's following the BAB market closely and may invest in it.
Watch out for the regulators. And it's not just one type of regulator – with a number threatening to impact infrastructure-related capital flows and performance, it's hard to know where to look. There's the politically motivated AIFM Directive that one speaker claimed might “kill the ability to raise funds on an international basis”. Then there's regulation relating to financial institutions that many fear will make moving capital off organisations' balance sheets into infrastructure such a costly operation that it may not seem worth it. Add to this the industry-specific regulation that many infrastructure investors are vulnerable to and it becomes obvious that the infrastructure asset class needs to get organised and make sure its views are heard when it comes to issues that might hurt it.
Seek marriage counseling. When LPs at the conference were asked if they received all the information they needed from their GPs, a resounding 62 percent said “no”, with only 38 percent satisfied with the quality of the information they were getting. Funnily enough, when GPs were subsequently asked if they felt they provided their LPs with all the information they needed, the result was inversely proportional, with 62 percent answering “yes” and only 38 percent feeling they should provide them with more information. Clearly, there is work to be done in ironing out this disparity. But the good news is that all the participants are committed to their relationship, with the word “marriage” frequently popping up to describe it. Counselors, stand ready.
T is for transparency. In Berlin, LPs also overwhelmingly called for more transparency on everything from fees, to asset valuations, to general information on the day-to-day running of the funds they invest in. GPs understandably raised the concern that calls for more information and/or more LP participation might seriously impede the decision-making process (one person even asked anonymously why bother to become a limited partner at all if you just want to “interfere” with everything). Still, the fact that infrastructure LPs are being quite vocal about the issue means that GPs hoping to win their trust will have to be more transparent than ever.
One final take-away for those enjoying the Berlin dining scene: beware of all-you-can eat schnitzel bars that charge only €5 for a meal. They may be delicious, but in the aftermath one might feel much far better off with the €5 note firmly in pocket.