Infrastructure independence adding pressure

A move by an increasing number of infrastructure investors into direct and co-investments is putting more pressure on investment consultants, already squeezed by money manager competition and investor efforts to lower fees.

With the move to direct investment, co-investments and separately managed accounts, investors no longer need as much help choosing among various infrastructure fund managers. Instead, investors need assistance evaluating potential infrastructure investments, a job typically in the hands of a money manager.

Consultants, already in a business with low profit margins, are getting heat from investors to lower fees while providing more services. At the same time, funds of funds and other money managers are crossing into consultants' turf, offering consulting services as part of strategic partnerships or under the broad “solutions” category.

“As investors become more sophisticated in their understanding of, and approach to, the asset class (including increased adoption of co-invest and direct investment strategies in some cases), "traditional' generalist consultants will find themselves under increasing pressure,” said Toby Buscombe, principal and global head of infrastructure in the London office of Mercer LLC.

Some consultants, including Mercer, are fighting back by hiring executives from infrastructure managers who can help investors evaluate and select infrastructure projects.

Mercer, Mr. Buscombe noted, has responded to the latest challenge “with the ramp-up in its own specialized infrastructure consulting unit.”

Mr. Buscombe, who joined Mercer from alternatives manager Access Capital Advisers in December 2011, this month was appointed global head of infrastructure investments. Mercer now has five specialists dedicated to the asset class, with plans to increase that in the coming year, Mr. Buscombe said. Three years ago Mercer effectively had one specialist dedicated to infrastructure.

“This has reflected a targeted strategy of bringing investment professionals with deep backgrounds in direct infrastructure investing (across both equity and debt) into the team to step up our offering,” he said.

Mercer is doing so to keep up with expanding infrastructure investment market.

“Compared to a decade ago, it's a more sophisticated market, certainly a more competitive market facing investors,” Mr. Buscombe said.

Consulting firm StepStone Group LP, San Diego, hired three executives to form a real assets group. Two of the team come from infrastructure manager Macquarie Group, and one is from investment consultant Meketa Investment Group.

“We believe there is an opportunity for advisers to provide customized solutions to assist in building infrastructure portfolios that combine a combination of funds, co-investments and secondaries,” said Monte Brem, partner and CEO of StepStone.

The move from commingled funds is due to investors being burned by infrastructure during the financial crisis. The supposedly low-risk, steady-return funds turned out to have neither of those attributes. Instead, a number of infrastructure funds were highly leveraged and performed poorly. Investors now are moving to gain control over the process by investing directly or co-investing with managers.

Infrastructure investing is more popular than ever. Preqin, the London-based alternative investment research firm, now tracks more than 2,100 institutional investors actively investing in infrastructure, compared with just less than 1,000 in January 2011 when it began tracking the asset class.

Interest in direct investment is rising rapidly as well, with 137 institutional investors looking to make direct investments now, up from 49 in 2011, according to Preqin data.

“This clearly shows an uptick in the number of pension funds looking to make direct investments in infrastructure assets, despite the overall proportion (of investors favoring unlisted funds, direct investments and listed funds) remaining largely similar to previous years,” wrote Elliot Bradbrook, manager, infrastructure at Preqin, in an e-mail.

Also, a few large institutional investors are adding infrastructure teams to their staffs so they can make direct investments, said Duncan Hale, senior investment consultant and head of infrastructure research in the London office of Towers Watson & Co.

The £40 billion ($65.5 billion) Universities Superannuation Scheme, Liverpool, England, has been building an infrastructure investment team, sources say, as has the Abu Dhabi Investment Authority, which is estimated to have $627 billion in assets.

“Current investments are driven by the element of control. It's a reflection of the lack of discipline by some of the high-profile managers out there,” Mr. Hale said. “Funds were invested in assets that people didn't think were infrastructure, such as car parks and energy generation facilities with merchant risk.”

Larger pension funds are bringing in-house asset management capabilities they didn't previously have, but they are doing it in a tailored way, he said.

“They want more discretion and are defining infrastructure they want to own,” Mr. Buscombe said. “In all likelihood, the vast bulk of investors will continue to invest via external managers in some form or another, reflecting size and resource constraints.”

Investors also are taking secondary stakes in assets and investing alongside general partners with which they have made previous investments. “There's an increasing focus on doing some direct investments, (but) in practice most is of the co-investment nature,” Mr. Buscombe said.

And those co-investments don't have the same requirements for consulting support, he said, because the lion's share of co-investments is made with existing managers. Instead, investors need assistance assessing the investment opportunity.

“Mercer recognized infrastructure is a very complex asset class — and one (in which) we expect continued growth over the years ahead — and built out a specialist infrastructure team,” Mr. Buscombe said. “Mercer hired myself and other specialists that come out of direct investment ... to help clients to take a direct approach.“

Unlike private equity, it is not enough for infrastructure consultants to help choose between the best and worst managers, Mr. Hale said. Instead, investors are looking to consultants to help them “create structures that are more appropriate. ... While some clients are going direct and building up teams, the vast number of clients are looking to find other and more innovative ways to access the asset class,” he said.

They include aggregation vehicles and separately managed accounts, which give investors more control over the investments, Mr. Hale said.