Heydays past, infrastructure firms feel heat

Infrastructure managers are having a tough time raising their latest funds, signaling an expected industry shakeout.

The managers are almost out of money from the 2006-2008 heydays when about 50 funds collectively raised close to $50 billion a year, mostly in private equity-style funds.

Last year, a little more than half that was raised, with most of the money going to just a few managers.

Industry Funds Management, for example, raised a total of $8.3 billion for an infrastructure fund last year. By contrast, CVC Capital Partners Ltd. called it quits on efforts to raise a e2 billion ($2.6 billion) infrastructure fund, even though it's about to close on a e10.5 billion leveraged buyout fund.

Infrastructure fund managers closed on $26.9 billion last year, down 67% from the $44.8 billion raised in 2008.

Concentration of assets in the hands of a smaller group of managers will cause a drop-off in the number of infrastructure managers, with managers focused on stable, income-producing investments especially vulnerable, said Duncan Hale, senior investment consultant and head of global infrastructure at Towers Watson & Co. in London.

There's pressure on infrastructure managers' business models that will result in some managers merging and others fading away over time, Mr. Hale said.

Traditional infrastructure vehicles have a five-year investment period, which means many of the funds raised in 2007 and 2008 are coming to the end of the their investment periods — the time in which managers have to spend the capital raised. Now, these same managers are out raising their next funds, and are finding less money being invested in infrastructure, Mr. Hale said.

According to London-based alternative investment research firm Preqin, 144 infrastructure funds are attempting to secure a total of $93 billion from increasingly choosy investors. While there has been an increase in institutions creating broad “real asset” portfolios, infrastructure assets dropped 10.4% as of Dec. 31, according to the most recent of Pensions & Investments' annual surveys of managers of U.S. institutional, tax-exempt assets.

“There's a smaller pie for people to take a piece of,” Mr. Hale said, and most of the pie is being taken by a handful of managers.

“Winners are raising lots of money and losers are not necessarily raising any,” Mr. Hale said.

Indeed, the 10 largest infrastructure money managers accounted for 45% of the capital raised in closed-end funds in the 10 years through June 30, according to Preqin. The top 10 managers raised $103 billion of the $231 billion raised over the past 10 years.

To survive, some managers are testing different models, Mr. Hale said. They are considering changing to funds with investment periods that last 10 to 15 years or to an evergreen approach, with funds lasting even longer, he said. Other managers are starting to invest in infrastructure debt and advising the very largest investors looking to make direct investments in infrastructure.

However, Mr. Hale noted, “for most investors, investing in well-aligned pooled funds is a better governance solution for them than owning these assets directly.”

Open-end funds are starting to look more attractive than closed-end funds, he said. Both IFM and J.P. Morgan Asset Management offer open-end funds.

Still, offering an open-end structure is not a foolproof recipe for survival. J.P. Morgan Asset Management's infrastructure business has gone through some growing pains. There has been some rejiggering in the executive ranks that culminated in March with Paul Ryan being named CEO of OECD infrastructure equity and debt from his post as a managing director and co-head of the bank's public finance banking unit.

“Unlike private equity, in infrastructure — really the whole real-asset area — there has not been a preferred fund structure,” said Stephen Nesbitt, CEO of alternative investment consulting firm Cliffwater LLC, Marina del Rey, Calif. “There are some open-end structures, partially open-end structures and closed-end structures and the deal terms can vary significantly.”

Markus Hottenrott, chief investment officer of Morgan Stanley Investment Management's infrastructure unit in London, contends the open-ended model only works for core infrastructure assets. Even then, he said, the “ideal holding structure” for core infrastructure — which he defines as assets that realistically justify 8% to 10% target internal rate of returns — is direct ownership by institutional investors such as pension plans, sovereign wealth funds and insurance companies.

However, direct investing requires a certain critical mass to build and maintain an internal team, he said.

Some investors are seeking alternatives to the private equity, closed-end model, but open-end funds are not necessarily the answer, Mr. Hottenrott said.

“Some people argue that because infrastructure investing is in long-dated assets, there should be long-term capital structures, i.e. long-term debt,” he said. “They may ask themselves, "Shouldn't we have open-ended, perpetual exposure to these assets?' The reality is there have not been that many (open end) funds.”

What's more, the open-end fund structure gives limited partners only “a limited degree of direct influence,” he argued. Investors have limited governance rights, and not all open-end models give investors redemption rights.

Much of what is happening in the industry is the result of growing pains of a relatively new asset class, said Mathias Burghardt, senior managing director and head of the infrastructure group at AXA Private Equity, Paris.

A number of firms were raising massive infrastructure funds and spending heavily before the 2008 financial crisis, Mr. Burghardt said. “They were paying sometimes aggressive prices and the debt was quite cheap,” he explained. “When the crisis hit, the largest players were hit more than others and so a lot of U.S. managers, particularly U.S. bank-managed funds, were hit hard.”

Many firms are struggling now because they paid too much for assets and used too much debt then. “They were too eager to deploy money,” he said.

Again, there are limits.

AXA Private Equity finished raising a e1.8 billion infrastructure fund in March, including a e300 million co-investment vehicle. He attributed the success to the addition of new, mostly European and Asian investors to the mix of investors.

“U.S. investors show interest, but are worried about the European economic situation. But my impression is that they are getting over that,” he said.

In the end, it's all about returns, said Marietta Moshiashvili, New York-based managing director and portfolio manager of TIAA-CREF's private infrastructure portfolio.

Many of the managers that raised funds before the crisis were raising infrastructure funds for the first time. Now that investors have track records on which to base their investment decisions, some managers have not been able to raise a second fund and have stopped fundraising.

“We are seeing fund managers that are not as successful, and some are offering mixed messages to the market,” Ms. Moshiashvili said.

But it is part of the maturation of the asset class.

“There's more clarity in defining winners and losers in the industry,” she said.