Infrastructure fundraising: A beast with two heads

Canada Pension Plan Investment Board's (CPPIB) acquisition of Intoll Group and Queensland Investment Corporation's (QIC) purchase of Queensland Motorways sent a shockwave through Asian infrastructure investment. They contributed the lion's share of the $8 billion deployed in the asset class in 2010, nearly 50% more than the sum committed in 2007 and 2008 combined, when the pre-global financial crisis market was at its peak. 

The deals had three characteristics in common: each was worth around $3 billion; each primarily involved toll road assets in Australia; and, crucially, each represented a full buyout by an institutional investor acting independently of a third-party fund manager.

Was this to be the new normal, pension funds and sovereign wealth funds acting solo or in concert to secure plumb infrastructure assets - with no management fees and no obligation to exit after 10 years? This may have been the case in certain regions, but not Asia, statistics suggest: the Intoll and Queensland Motorways deals have yet to be topped. There is, however, still time.

"The private equity investor market is evolving into two tiers, with the top tier comprising large sovereign wealth funds and pension funds with more than say $100 billion in assets under management seeing lots of interesting direct investments, co-investments and fund-style investments," says Andrew Yee, global head of infrastructure in Standard Chartered Bank's principal finance division. "These investors also tend to be longer term capital so have a higher ratio of direct and co-investments with materially lower fees and carry, which enhances their returns."

There is an argument to be made that the future of infrastructure investing will be dominated by these larger players demanding customized separate accounts rather than blind pools. They will then sweep up the assets into their own evergreen platforms and employ internal teams to go out and buy even more, acting as competition to the managers they once backed.

Unsurprisingly, the reality is more nuanced, with LP preferences varying according to geography, resources and appetite for risk. The lower of these two tiers - smaller investors choosing pre-packaged offerings with less freedom to shape their portfolios plus higher costs and lower returns - is not to be ignored.

Bucking the trend

Infrastructure fundraising in Asia has never been straightforward. Looking back at activity since 2003, AVCJ records show that no more than 10 infrastructure vehicles have been raised in the region in any one year. The high watermark remains 2008, when $2.94 billion was committed by LPs, although this doesn't include global funds or generic vehicles that dabble in infrastructure.

The subsequent drop-off reflects the trend seen in broader private equity, but this trend has been wholeheartedly bucked in 2013. While PE fundraising remains in the doldrums, infrastructure vehicles have received $2.87 billion year-to-date, up by more than $1 billion on 2012 as a whole.

Indeed, Macquarie Infrastructure & Real Assets (MIRA) claims the last 12 months of fundraising globally have been the best it has seen in the last 7-8 years, and the balance is actually shifting towards traditional funds.

"A significant amount of this capital went into funds, although money was raised for separate managed accounts and directs" says Steve Gross, a senior managing director at MIRA. "A significant increase in the portion of that money was raised from larger investors."

Gross reconciles these phenomena with anecdotal evidence of increased investor demand for direct infrastructure exposure by stressing that it is merely the means through which investors get this exposure that has changed. In recent years numerous LPs have pursued deals independently, but with mixed success, and they are now turning back to the fund-plus-co-investment model.

On top of this, while most LPs want to know about co-investment opportunities, not many have the internal capacity to act on them. Even fewer have large enough dedicated teams to operate independently - and especially not in emerging markets, where the potential for strong returns is tempered by lower transparency and higher risk.

This is certainly the experience of IDFC Project Equity, which recently reached a $644 million first close on its second India infrastructure fund and is targeting a $1 billion final close by the first quarter of next year. The GP has received re-ups from a fair number of investors and added 4-5 new faces, and CEO M.K. Sinha says there continues to be strong interest from pension funds and sovereign wealth funds that are keen to co-invest.

Standard Chartered's Yee adds notes several of these investors - including groups from Canada and the Middle East - kept their powder dry while the India market was peaking in 2008-2009. Those that didn't hold back have, in many cases, lost 20-30% on the value of the asset and a further 10-15% on foreign exchange. So there is an opportunity for investors with minimal exposure to take advantage of low valuations in the expectation that the market and the currency will be stronger in 10 years' time.

But are they willing to go it alone? Sinha says no. "I think a lot of these investors realize they lack the connections in the local market to put meaningful dollars to work. We are a beneficiary of that environment where a lot of people who want direct exposure also want a local manager alongside them."

Inspecting the pipeline

Even if LPs are still willing to follow the fund route, blind pool funds remain an area of concern. As such, the deal pipeline an infrastructure-focused GP has in place at the beginning of fundraising comes under intense scrutiny. A manager who makes a strong investment early on in the process - one that illustrates the capacity for co-investment - might be able to ride on the momentum to a final close.

Asked to list the qualities he would want to see when marketing an Asia infrastructure GP, Vincent Ng, a partner at placement agent Atlantic-Pacific Capital identified three things: an ability to show how and through what structures outsize returns will be generated, particularly on the greenfield side; a well-defined strategy that highlights the GP's competitive advantage in markets often dominated by strategic and government-linked players; and a local team that can offer good access to deal flow and relationships with regulators.

"Some groups might have all this but then they don't have a track record in asset management," he adds.

The largest non government-affiliated funds to reach first or final closes in Asia over the last 12 months can claim to meet several of these requirements. In the case of IDFC, it is estimated that, available co-investment capital included, the GP had about $1 billion in dry powder by the first close and 6-7 companies in the pipeline. LPs are already engaged in due diligence on some co-investment opportunities.
IDFC didn't offer any co-investment in its last fund because the deal sizes were smaller. This time around the fund's transaction sweet spot is expected to be $75-100 million but deal sizes could run into the $150-200 million range, and even up to $250 million. Sinha sees particular potential for big-ticket deals in the power generation space, but wherever the fund goes, it will focus on large operating assets with a track record. There will be no greenfield.

"The market in India has evolved," he explains. "Operating assets that are low risk are coming on the market and they can absorb larger investment amounts. This will generate opportunities for co-investment. There are a lot of good assets with distressed developers."

By the time Equis Funds Group announced a final close of $647 million on its debut Asia energy and infrastructure fund in January of this year - exceeding the $500 million target - the firm had already completed two investments and was finalizing its third and fourth deals. According to Mounir Guen, CEO of MVision, which placed the fund, Equis already had about five investment platforms in sight when it commenced marketing efforts.

The GP also benefited from being an experienced quantity - a number of the founding partners were previously with Macquarie Group and helped establish funds throughout the region.

"There are a lot of opportunities in Asia and experience in terms of executing those opportunities is very much sought after by investors," Guen adds.

Singapore-based Capital Advisors Partners Asia (CapAsia), meanwhile, reached a first close of $100 million on its third fund earlier this year with a view to accumulating $350 million by the end of December. The vehicle focuses on Southeast Asia, seeking minority stakes in assets of around $30 million but ready to go to $100-150 million through co-investment.

CapAsia ASEAN Infrastructure III received commitments from Japan Bank for International Cooperation and the Bank of Tokyo-Mitsubishi UFJ, each of which put in up to $25 million. Speaking to AVCJ in January, CapAsia CEO Johan Bastin said he expected Japanese institutions to become more active in overseas infrastructure.

Having initially focuseding on Organization for Economic Cooperation and Development (OECD) member nations, Japanese LPs are now considering Southeast Asia.

This offers a snapshot of how the infrastructure LP base is evolving and, by extension, where Asia fits into investors' portfolios.

A sliding scale

The typical first step is to go for low-risk assets. One of the fundamental attractions of infrastructure over other private market investments is long-term returns coupled with an element of downside protection. This draws LPs to core infrastructure assets in OECD markets, such as UK water, that offer a stable customer base, transparent regulation, and predictable inflation-linked revenue streams.

Once a developed portfolio is established, an investor might consider diversification and adding some emerging markets exposure, starting with regions close to home - hence the Japanese interest in Southeast Asia, a geography in which domestic corporations have been active for years.

An LP's infrastructure appetite at a certain point in time depends on where it sits on this development curve. Anthony Fasso, chief executive of AMP Capital's international business, notes the contrasting profiles of investors in his firm's most infrastructure debt funds with those that opt for equity products.

AMP's most recent infrastructure debt fund reached a first close of more than $300 million in August. It is the first fund of its type that Mitsubishi UFJ Trust and Banking Corp, AMP's strategic partner in Japan, has marketed to local investors and they are strongly represented in the first close, alongside one of South Korea's top insurance companies. The average investment in the fund is $20 million, much of it coming from insurers and defined benefit pension plans looking for cash-yielding assets to match long-date liabilities.

Demand for AMP's equity infrastructure funds, meanwhile, is split between mid-size global pension and superannuation funds that want to put $20-50 million to work, and then large superannuation and sovereign players looking for separate accounts of $100 million or more.

Fundraising is, therefore, no zero-sum game. For every large-scale institution with the resources to support a separate account or even a stand-alone investment team, there will be a score or more of smaller players lacking the skill, scale or mandate to make anything apart from fund commitments. But those funds must be able to offer local competitive advantages, co-investment and a visible deal pipeline.

And, one way or another, capital is coming to Asian infrastructure. MIRA's Gross reports increased interest from large institutions and also more reverse inquiries from consultants representing big and small investors, all of whom are tracking the strong yield in developed Asia and strong growth in developing Asia.

"This makes it a good diversifier, so if you add listed Asian infrastructure into a portfolio you increase the potential return for a given level of risk," Gross adds. "And then Asian infrastructure on an unlisted basis provides a real opportunity for alpha and outperformance of the listed markets and therefore even greater improvement in the overall risk-adjusted returns in an investors portfolio."

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• Topics
• GPs
• LPs
• Infrastructure
• Australasia
• South Asia
• Greater China
• IDFC Private Equity
• Canada Pension Plan Investment Board (CPPIB)
• AMP Capital Investors
• Infrastructure
• Australia
• India
• China