Many institutional investors in infrastructure continue to struggle with the discrepancy between the risk/return profile of infrastructure assets, and the level of management fees charged by fund managers utilizing the private equity fund model. Investors are now largely unwilling to pay high fees, particularly to managers without a proven track record or to those targeting assets which are likely to generate a lower rate of return. However, many GPs continue to operate under the traditional 2/20 private equity structure. Of the funds currently raising capital and vintage 2010- 2012 funds closed 53% have a management fee of 2%, showing that despite increased investor pressure, over half of fund managers continue to apply the private equity model to infrastructure funds.
Another issue is the lack of clear performance benchmarks for the infrastructure industry as a whole. The majority of unlisted infrastructure funds were launched post-2004; as a result there is only limited performance data available for these vehicles. According to Preqin’s Infrastructure Online database, 84% of unlisted infrastructure funds target a net IRR of between 10% and 20%. This is lower than the level of return traditionally sought by private equity or real estate GPs. However, when comparing the median net IRRs achieved by infrastructure funds of vintages 1993-1999 against other private equity strategies, the performance actually achieved by infrastructure vehicles is similar (9% for infrastructure funds, 11% for buyout vehicles, and 13% for real estate funds). Fund managers able to demonstrate a record of good past performance are more likely to be successful in the current market, although few firms are realistically able to do so.
The availability and high cost of debt financing in the current environment is also limiting investor appetite and affecting deal flow. The number of deals completed by unlisted infrastructure fund managers grew steadily year-on-year prior to the financial crisis (from 80 in 2004 to 290 in 2008), but this has since levelled out as banks are becoming less inclined to provide long-term affordable debt financing. A growing number of fund managers are launching debt funds in order to compensate for the shortfall in infrastructure debt financing, but this remains a niche part of the infrastructure fundraising market.
Though many fund managers are becoming more attuned to investor concerns, the future growth of the unlisted fundraising market is dependent on a larger effort to resolve these issues. Managers seeking to raise capital need to be prepared to consider investors’ concerns, and address and mitigate them if necessary in order to secure capital commitments. A greater alignment of interest between GPs and LPs has the potential to encourage more investors to become active in the asset class.