Infrastructure: Building partners

When IDFC Alternatives reached a final close on its second infrastructure fund this month, the GP was looking at a very different environment to the one it faced when raising the maiden vehicle six years earlier.

First, the macroeconomic situation in India - and indeed globally- is clearly in much better shape than it was during the period immediately after the global financial crisis. Second, the recent election of Narendra Modi and the country's well-publicized $1 trillion infrastructure opportunity has helped whet investor appetite.

Accordingly, India Infrastructure Fund II met with a strong demand for co-investment opportunities from LPs. The $900 million fund corpus is supported by a further $800 million that will go directly into deals alongside the fund, on a zero-fee basis.

"Clearly, there has been a substantial increase of interest in our co-investment pipeline," says M.K. Sinha, managing director and CEO of IDFC Alternatives. "We would expect there to be two or three deals where we can bring in significant additional capital."

LPs seeking more co-invest opportunities is a well-established phenomenon across the broader asset class and infrastructure is no exception. Investors are comfortable going into projects directly and they like how it reduces the fee burden tied to the fund. However, the way in which LPs do this depends on the jurisdiction they invest in, the partnerships they can foster and the resources they can bring to bear.

Looking at co-investment in isolation, a recent poll released by Preqin supports the idea that more investors are looking to get direct exposure to infrastructure by partnering with local fund managers. While the proportion of LPs interested in co-investments globally still remains small - around 13% of the 1,700 active infrastructure investors polled said they were open to co-investment - this still represents an increase on the 11% reported in 2013. A further 3% are not currently active but considering the strategy.

The same survey data also show that of those LPs with an appetite for co-investment, around 20% reside in Asia, compared to 38% and 31% in North America and Europe, respectively. Last year the Asia figure was 15%. Demand also varies between different types of LP. For example, public sector pension account make up 19% of the infrastructure co-investors, while other include insurance firms (8%), asset managers (9%), and banks (5%).

"I think managers are recognizing how important it is to their own clients. It is certainly becoming important to many LPs," says Benjamin Haan, managing director in Partners Group's private infrastructure team. "We were relatively earlier movers on the co-investment side. Several years ago we might have been the only investor able to do co-investments, but now there are many LPs in these funds that have a co-invest capability of their own."

Mutual benefits

For the GP, co-investment brings in the extra capital needed to access larger infrastructure projects. Deals become possible that previously were not due to limits on the amount that a fund can deploy in a single investment. On the LP side, perhaps the most obvious benefit is the prospect of higher returns by essentially doubling down on the choice assets within a fund's portfolio. And, just like the GP, they stand to gain from making larger bets than would otherwise have been possible.

"It's a dual benefit of getting exposure to the good assets alongside knowledgeable local manager and getting a relief on the fee commitment," says IDFC's Sinha. "There is an alignment of stars there. The local managers bring value to the table in terms of their understanding of the market, and the LPs get comfort from working with partners who can also offer ongoing portfolio management support."

However, when seeking co-investment opportunities in developing markets like India and China - where risks are high and transparency is low - it is paramount that LPs identify a partner with whom they are comfortable.

Partners Group has been an active infrastructure investor in Asia and currently has around $9 billion worth of assets under management in the region. It is engaged across developed and developing markets, doing direct deals and making co-investments. One of the firm's highest-profile deals was in India where it joined a consortium led by Singapore's Temasek Holdings that paid $1 billion for a 10% stake in Bharti Infratel, the telecom towers subsidiary of mobile operator Bharti Airtel.

Haan emphasizes the importance of building strong relationships with a select group of managers when looking at co-investment opportunities.

"We focus on a small number of key relationships in each of the markets we target rather than a ‘scattergun' approach," he explains. "And with those key relationships we seek to invest meaningful amounts of capital and work side-by-side with them on certain transactions."

For GPs, the ideal co-investment partner inevitably depends on the nature of the transaction. Sharat Goyal, managing director with AMP Capital, stresses the importance of identifying partners that complementary skills and strengths to the deal.

A local investment house, for example, would be well-placed to handle relationships with other counterparties, particularly on the government and regulatory side. A development finance institution (DFI) such as the International Finance Corporation (IFC) or the UK's CDC Group, meanwhile, might attract other co-investors and facilitate access to cheaper lines of debt.

"These are advantages that we cannot bring to the table," says Goyal. "So it is good to have a partner that can fill in the gaps and make deals more workable."

Partners Group's Haan adds that ensuring an alignment of interest with fund managers is vital. The Partners Group approach to getting comfortable with a manger and ensuring there is a strong pipeline of co-investment opportunities does not only involve looking at the size of the deals typically targeted. A manager's track record on co-investment is also scrutinized, as well as how they are incentivized to offer such opportunities. Is it mandated or just an aspirational goal?

"The key when you are investing alongside others is getting the governance arrangements right," Haan says. "You have to take into account what the shareholders' agreement looks like, whether you are aligned on exit, how much you trust that partner and whether it is a partner you have invested in."

Timely teamwork

While additional capital may be welcome, co-investment relationships can also bring added complications to a deal process and potential delays in decision-making. This point was highlighted by Simon Lund, a principal with HarbourVest Partners in Hong Kong, at the AVCJ Real Assets Forum earlier this year. He observed that the increased desire for co-investment among LPs is not always matched by an ability to consummate a deal against the clock.

"We try to only work with groups were they have discretion, where they have proven that they can execute against a set time-frame, whether it is two days or three days," says Lund. "When one talks to private equity GPs that have growing ranks of clients who are seeking co-investment, their experiences generally cross a broad spectrum. Oftentimes they will take down a deal and syndicate right afterwards so it doesn't interrupt the transaction."

Downstream syndication relieves time pressure, giving LPs longer to assess a transaction, although the terms are less favorable than when participating up front. A particular stumbling block - regardless of jurisdiction - can be LPs' internal approval processes.

"There have been situations where we've had to do the same exercise twice over: once with our own investment committee, and then having to explain the deal all over again to individual co-investors," says Bamasish Paul, senior vice president with Brookfield Asset Management in Mumbai. "The due diligence process is longer, and at times that effects our ability to execute deals faster."

Co-investment may be the preferred approach in emerging Asia's infrastructure sector but that is not necessarily the case in the region's developed markets like Japan and Australia. Increasingly, pension funds and sovereign wealth funds - which want to deploy large sums - seek out direct investments on their own.

The reasons for this are two-fold. First, developed markets are inherently less risky. The assets are often operational and the returns might be guaranteed by regulators, so investors going in have a very clear idea of what they will get coming out. Second, the infrastructure investment thesis in more mature markets has been proven several times over and the investors themselves may have built up considerable on-the-ground experience.

For example, Australia's superannuation funds have been investing local infrastructure assets since the 1990s. AustralianSuper allocates 10% of overall portfolio to infrastructure, far exceeding the 2% that the California Public Employees' Retirement System (CalPERS) deploys across infrastructure and timberland.

AustralianSuper is also a seasoned direct investor. Last year, it teamed up with three other superannuation funds, Abu Dhabi Investment Authority (ADIA) and IFM Investors to acquire 99-year leases on Port Botany and Port Kembla for A$5.07 billion ($5 billion). While this was a consortium participating in an auction process, the superannuation funds went in with an experienced manager in the form of IFM.
There are also developed market opportunities that fall beyond the mainstream.

Indeed, the valuations commanded by the biggest brownfield infrastructure projects in developed market are an incentive for some managers to look further afield. 

In January, Equis Funds Group and Partners Group together led a $250 million investment in a dedicated Japanese solar platform to be operated by Nippon Renewable Energy (NRE). For both groups it represented a first foray into Japanese infrastructure and a solar market that remains underpenetrated by private equity. In this case Equis - which raised its $647 million debut pan-Asian energy and infrastructure fund last year - also brought in Babson Capital, LGsuper and Qantas Superannuation as co-investors

Haan says that while Partners Group does direct investment and co-investment with local partners, the emphasis is on the former. One developing country where it exercises both these strategies is India. 

"We are huge believers in the importance of diversification, so all of our integrated programs have a high degree of diversification on many different factors: counterparties, countries, currencies, even investment types between doing direct, secondaries and primaries," says Haan. "Certainly one way to partly mitigate currency risk is to have a diversified program."

AMP's Goyal makes the point that India could see more direct investment in future as investors get more comfortable with the market and build out their presence in the country. Those seeking co-investment today could end up doing more direct investment tomorrow. "It is difficult to identify one common objective for those LPs who do co-investment," says Goyal. "But certainly you can deduce that some are wetting their feet with co-investment before they go direct."

Canada Pension Plan Investment Board, for example, recently announced its first direct deal in the country with an agreement to invest INR20 billion ($322 million) in Larsen & Toubro subsidiary L&T Infrastructure Development Projects. Also this year, Netherlands-based APG Asset Management teamed up with local player Piramal Enterprises to invest up to $1 billion in the sector over the next three years.

For his part, IDFC's Sinha thinks a market as large and nuanced as India is one that will require LPs to build up experience and a track record before pursuing all the available opportunities. The same is true of any emerging market.

"They can selectively participate but to really cover this market in its entirety you need a long-term, stable model," he says. "Not everybody can replicate a big shop in India and pursue deals directly."

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• Topics
• South Asia
• Australasia
• Infrastructure
• Infrastructure
• LPs
• AMP Capital Investors
• Infrastructure
• India
• Australia
• LPs
• Co-investment
• Direct investment