LPs and infrastructure: Custom connections

Infrastructure has not been a particularly magnetic asset class in Asia, but that could change as modes of access evolve. Part of this process will be a matter of navigating themes related to increased competition that are already prevalent across the alternatives space. Part of it will be redefining what constitutes an infrastructure play.

In the latest survey from EDHEC Infrastructure Institute, the number of respondents wanting to increase their exposure to developing markets fell to 52% from 82% in 2017. Waning interest has been attributed to the significant resources required to access individual transactions and the specialized knowledge required to realize the best opportunities. But in the end, it appears likely that these same headwinds will be what finally gives global institutional investors the comfort they seek. 

Rising concerns about the expertise needed to succeed in Asian infrastructure have counterintuitively paralleled demand for deeper exposure. To some extent, this is due to a lack of traditional infrastructure funds in the region and the structural solutions that emerge at deal level as LPs seek to deploy larger sums. The development has been facilitated by GPs seeking to out-scale each other by offering concessions in the form of increased flexibility on co-investment and operational-level exposure.  

It’s a fairly concentrated set of GPs focused on infrastructure globally

The result has been a gradual transition from blind pool to more targeted vehicles, usually tailored to meet the needs of an anchor LP. It enables LPs to access the diversification benefits and economic upside that come with an Asia program, while sticking close to a familiar category they made work in a more comfortable geography. These are concentrated bets with slightly skewed, quasi-infrastructure return profiles, arguably stretching the definition of the asset class. But for LPs receptive to the industry-specific value-add philosophies of private equity, an “infra-plus” inroad to Asia is now firmly established.    

“The traditional fund model is not straightforward in Asia because it’s harder to have high-level convictions about infrastructure in the region given its mixed historical track record, and the biggest investors with Asian allocations for the asset class are looking for something a little more bespoke,” observes Enrique Cuan, a managing partner at placement agent Mercury Capital Advisors. “We’re seeing more deals on a niche basis with groups that are not investors in generalist managers. They’re seeing themes that have worked in developed markets where geographic expansion seems to make sense.”

The strategy has been applied across the gamut of infrastructure styles, but categories with more involved operational requirements do appear to be the best match. Recent examples include data center platform expansions in China by GIC Private and Warburg Pincus, the latter of which is known for establishing vehicles in the region largely as a service to its core LPs in the state government of Michigan. Renewable energy also fits the bill nicely, with some of the latest activity including CDC Group backing an Indian solar and wind platform.

Beyond funds

The basic diversification and growth prospects associated with Asia are key drivers here, along with macro pressures to deploy amounts too large to comfortably sit in a fund structure. But as the theme develops, it has increasingly exposed a fundamental friction between the concept of a blind pool and the premeditated allocations across sectors and geographies that define most institutional investors. Specialized infrastructure vehicles are therefore seen as achieving better alignment between LPs and GPs.

Meanwhile, non-fund strategies are seen as opening the door to more direct collaboration with credible operating partners and regional investors that would be sidelined by less flexible structures. For example, Japan Solar, a platform seeded by Equis Group and Partners Group and operated by Nippon Renewable Energy, was said to be up to 80% funded by local investors before eventually being acquired – as part of a portfolio of assets – by Global Investment Partners in deal worth $5 billion. Other incentives include more agreeable fee structures and more measurable risk at the industry level.

This is playing out in a range of joint venture funds, consortia, non-fund platforms, and separately managed accounts. These can include retail funds backed by high net worth individuals and single-asset funds, an increasingly popular approach among Korean institutional investors targeting infrastructure in North Asia and globally. Other models can resemble entirely separate companies. 

Equis, for example, is expected to effectively abandon the traditional fund structure with its upcoming vehicle in favor of a kind of GP-LP holding company that will raise up to $1 billion and deploy on a when-needed basis. The platform, which will recycle gains back into new development projects, is designed to appeal to LPs across the infrastructure experience spectrum. In theory, it could also support yet another entry to the asset class by fueling a secondaries market. 

“If you’re making primary fund commitments, it’s going to take a long time to build up an infrastructure program, so secondary funds have recently been trying to ramp up their exposure to the asset class quicker,” says Niklas Amundsson, a partner at Monument Group. “I think that’s important and a growing trend, but the challenge will be that it’s a fairly concentrated set of GPs focused on infrastructure globally. It will be tricky for LPs to build a secondaries portfolio when they don’t have that much choice.”

Macquarie Group is generally considered the earliest mover in this space, having set up its infrastructure and real assets division MIRA in the early 2000s to manage a range of specialized vehicles, including listed funds. Widespread momentum would not come until midway through the following decade when the likes of Equis, the International Finance Corporation (IFC), Germany’s DEG, Caisse de dépôt et placement du Québec (CDPQ), and ICICI Venture began teaming up with energy giants such as Tata Power and CLP Group to set up variously structured operator-connected platforms. 

“Ten years ago, investors were quite open to pooled vehicles, but they’ve become very focused on staying in their zone of expertise with a longer holding patterns,” says Mounir Guen, CEO of MVision. “Most recently, we’re finding many of them are very knowledgeable about certain sectors, they’re going direct. They know that with blind pool vehicles, in order to raise the next fund, GPs have to sell the best assets, so those funds are not aligned with their long-term interests.”

Addressing uncertainty

Replicating developed market-style long-term holding strategies in the less proven markets of Asia remains subject to a number of prickly variables, however. These include questions around rule of law, the nationalization of assets, and hard-to-quantify factors such as the theft of electricity from poorly monitored power grids.  

Pricing this risk in funds that target the maze of cycles and country dynamics of Asia Pacific is a decidedly guesswork-reliant process. But even with niche vehicles, similar risks will re-emerge in a lack of diversification and multi-decade track records. 

While Australia and Japan can certainly play the long-hold card, less developed sub-regions will probably continue to be a tough sell for vehicles that envision strategies beyond fund-relevant timeframes. 

“Would I want to hold an asset for 30 years in China? I don’t know because the asset class isn’t that old in Asia, and it’s hard to understand the risk that far out,” says one industry participant. “Longer holds are attractive to a lot of investors that are looking at developed markets, but I’m just not sure that Asia offers those kinds of opportunities in the same way.”

This is not to discount the macro allure of Asian infrastructure as an underdeveloped sector in a fast-growing region. Indeed, the sector is the most substantive long-term engine of growth in many Asian markets, arguably including prized jurisdictions such as India and Indonesia. And there may be no better means of identifying the entries to this opportunity set than vehicles that are specially structured to exploit the specific sub-geography, industry, and project development stages that interest investors.  

“If anything, the US and Europe are even more difficult than Asia because the governments haven’t necessarily gotten into infrastructure or development programs, and the infrastructure that’s already there needs to be renovated,” Guen adds. “But in Asia, you’re dealing with greenfields, so you’re able to develop and open markets and economies and be part of government policy from the start.”

Policy developments may further this argument as they become more stringent in terms of environmental, social and governance (ESG) issues. The EDHEC survey found that substantially more infrastructure investors see ESG as a form of risk management that delivers lower, but stable returns compared to two years ago. A majority no longer see it dialing up their risk exposure in the name of societal gains.  

Infrastructure money with a strong ESG-driven or impact agenda is still a rarity in Asia, but if it continues to develop along these lines, it appears likely to cement the notion that tightly targeted, LP-guided platforms will be the key to unlocking the asset class in the region. But again, the specters that come with a hemisphere’s worth of developmental inconsistency are already keeping this outlook in check. 

“At the moment, we’re seeing each country legislate in its own way with its own [ESG] standards and it’s going to fragment and complicate the market,” says Will Myles, global director for growth programs at Royal Institution of Chartered Surveyors, based in Singapore. “I don’t think that’s going to stop investment, but it will certainly raise questions in investors’ minds about whether or not their objectives are being met. In many cases, standards haven’t been adopted at all. This has been the case in most of Southeast Asia.”   

 

SIDEBAR: Lending a hand  

The modernization of infrastructure is changing LP entry points to the asset class not only by necessitating more specialized, operator-connected vehicles, but also by putting a greater focus on leverage. Traditional projects, including most transportation assets such as toll roads, will continue to be financed with a debt-to-equity ratio of 50-50 to 60-40, whereas clean energy plants and data centers are now attracting 75% senior debt financing when offtake contracts are in place. 

This development has at least two major implications for global institutional investors looking to diversify their Asian infrastructure exposure. First, the booming trajectory of tech-related project construction implies debt strategies are going to play a significantly greater role in allocation planning. Renewables, for example, are projected to represent 70% of global electricity generation growth from 2017 to 2023, according to the International Energy Agency. 

Second, frontier markets will continue to be the most accessible markets for debt. Countries with more developed local currency liquidity, including Thailand, the Philippines and Malaysia, will see domestic banks fill the market, leaving few opportunities for outsiders. Financing for projects in Vietnam, Indonesia, and Myanmar, however, will be denominated in US dollars. This could represent a relative advantage for emerging market greenfield specialists such as Asian Infrastructure Investment Bank (AIIB). 

“These days, you’re going to see more debt financing for renewables projects from both commercial banks and multilateral development banks like us,” says James Lok, a principal investment operations specialist at AIIB focused on debt financing in the energy sector. “Most investors cannot finance coal-fired power projects at the moment, so they have no choice. It’s very hot, and we’re focusing a lot on renewable projects like solar, wind, geothermal, and hydro power plants, globally, but mostly in Asian emerging markets.”

AIIB is wasting no time with this agenda. In July, it partnered with Aberdeen Standard Investments to set up a $500 million program to issue green bonds and develop debt capital markets focused on promoting environmental, social and governance (ESG) related investing. This was followed last week with another $500 million commitment to an Asia climate bond portfolio in partnership with French asset manager Amundi. 

One area of concern as this and similar strategies begin to unfold is the idea that central banks are beginning to unwind their ultra-low interest rate policies, which should raise the cost of debt in emerging markets. Higher infrastructure financing costs would then slow down government build-out plans in the most desirable markets, and an environment already characterized by fierce investor competition for the best long-term deals might get even tighter.  

“Deal flow is quite limited, especially in Asia, where power projects, for example, can have PPAs [power purchase agreements] of 20 or even 30 years,” says Lok. “In Europe or Australia, debt is usually based on a mini-perm of 5-7 years. That doesn’t mean it’s more difficult to invest in infrastructure debt financing in Asia – it’s just a different structure, so you have to look at the country, PPA term, margin and tenor. And everybody is chasing these deals with acceptable contracted revenues.”

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• Topics
• LPs
• Infrastructure
• Fundraising
• Cleantech
• Credit
• Asia
• MVision
• Asian Infrastructure Investment Bank
• Real estate
• ESG