A new paper from bfinance (an independent financial services consultancy headquartered in London) discusses the “dramatically different era” into which infrastructure investing has entered over the last two years.
The paper, “DNA of a Manager Search: Infrastructure,” looks at three recent unlisted infrastructure searches, in order to glean some insight into how investors are going about finding managers in this space in an increasingly challenging environment.
The environment is challenging because returns have become skimpier, and in reaching to the higher returns of old, managers are taking on more risk than before, or at least different types of risk.
In terms of the products on offer, the report observes that listed infrastructures, which were “formerly the preserve of dedicated funds or mandates,” are now sometimes integrated with private infrastructure in the same vehicles.
In terms of market structure, bfinance reminds us that over the last two years mega-funds have emerged. Brookfield III is one of these, as is Global Infrastructures Partners III. Also, in May of last year Blackstone signed a memorandum of understanding with Saudi Arabia’s main sovereign wealth fund – together, they plan to create a new $40 billion vehicle for infrastructure investment.
So there’s a lot of money chasing returns that themselves have been squeezed of late. In that context, one has to be careful about one’s managers!
First Search: Bid Discipline
The first search that the paper discusses in some depth is that of a Canadian foundation that wanted to allocate C$50 million to unlisted infrastructure. It assessed 26 managers. It gradually narrowed that list down. But near the end of its search, the concern arose whether the preferred manager had been paying too much for assets in a high-valuation environment.
In order to address this search, it looked at that manager’s “successful and unsuccessful bids over the past three years and the evolution of pricing during those bidding processes.” A careful assessment vindicated the manager, finding that “despite high prices and competition for assets, the manager had retained appropriate bid discipline.”
In illustrating how tricky valuation issues can be, bfinance asks readers here to consider an onshore wind project as the infrastructure asset at issue. How should a disciplined manager go about bidding on that project? Assume further that the project is expected to have a 25-year lifecycle. How much of the bid will be dependent on returns expected after year 20? One can’t know with any great degree of confidence what power prices are going to be twenty years from now, or what the maintenance costs will be at that time or thereafter. A related question “Is there major refinancing risk during the life of project or will current debt amortize?”
Second Search: Core, Core-plus, Value Added
The second search examined here was that of a UK local government pension scheme that wanted to expand its existing infrastructure holdings with an eye to “pricing, size, inflation-hedging and more.”
Ultimately, it selected two new managers, one a US firm with a value-added focus, the other a European firm that invested in core and core plus infrastructure.
This search is also then an opportunity for vocabulary review. An infrastructure core fund firm looks for a highly predictable cash flow. This space can include schools, hospitals, and regulated utilities. A core-plus firm is willing to accept more risk from demand decline, and so may be looking to service companies. A value-added infrastructure firm, finally, is more interested in the growth of the value of the assets than in the cash flow, so it is willing to accept volatility in that cash flow.
Third Search: Widen the Universe
The final search of the triptych was that of a European pension fund that wanted to step up its ESG commitment, so it wanted to invest in the infrastructure for renewable energy.
“After detailed qualitative analysis and due diligence, two managers were selected: one with a global OECD focus and the other with a US focus. One of these had never previously participated in any consultant selection process of RFP.”
The lesson to be drawn here is that it is important not to narrow unduly one’s universe of possibilities, one might find what one wanted where one hadn’t expected, such as in funds that hadn’t previously qualified for analysis.
In the renewable field, (green or brown!) infrastructure investors should take note of the heterogeneous nature of the space, the ability of managers to adapt as the technology changes, and of course the implications for returns.