‘No wonder many funds seem to be struggling’

Infrastructure Investor approached three of Europe’s limited partner investors with the following question: “What are the keys to successfully raising money today, and what mistakes do funds typically make when approaching LPs?” The question elicited some strong responses, foremost among which was a sense that infrastructure funds are often not aligning themselves well with investor expectations.

Richard Moon, investment analyst – private equity and infrastructure, Railpen Investments, UK:

“Track record is likely to be an important factor in the manager’s ability to raise funds. We’ve not seen a large volume of exits from funds raised in 2005 to 2007 vintages and these are likely to be the most challenged in terms of performance. It may be difficult to raise capital on a limited exit track record. Because valuations of private market assets are, to some degree, subjective, the manager needs to be transparent as to how these valuations (for the unrealized portfolio) have been derived. It is up to the potential investor to make a judgment as to whether the manager’s portfolio is aggressively or conservatively marked.

In my opinion the other big issue is whether the fund structure and terms adequately incentivise the manager to target the appropriate risk profile. Depending on the risk appetite of the investor, 10- or 12-year closed-end funds may be an appropriate structure. In circumstances, however, where investors are seeking modest but steady returns from reliable long-term index-linked cash flows, other structures may be more appropriate. In my opinion, many funds are inappropriately structured to maximise benefit to the investing institution.

If an investor is focused on yield then the manager’s carried interest should be structured so as to incentivise consistent long-term yield enhancement rather than the generation of one-off capital gains. Another option would be to incentivise a fund manager by using a risk-adjusted benchmark. In this case, the benchmark should contain two components; the risk-free rate and an asset-specific risk premium.

The risk premium should incorporate a measure for asset beta as well as a leverage measure. Having a flexible hurdle associated with the risk of the asset should guard against managers taking excessive risk. Ideally, this should be a hurdle which challenges managers to show that they possess the ability to generate alpha.”

Dr. Christoph Künzle, vice president, SCM Strategic Capital Management, Switzerland:

“In infrastructure, we are looking for managers with proven track records of making money for their LPs through operational value creation or by securing stable long-term cash flows. This is consistent with our core investment philosophy.

While we actively source and review both income-focused (core) and capital gains-focused (opportunistic) infrastructure funds, we continue to see offerings that seem misaligned to us – particularly in the “core” space. In our view, you simply cannot charge private equity-like fees and carry with bond-like return expectations. No wonder many of those funds seem to be struggling in fundraising. Also, we insist on a substantial cash commitment from the investment team into their fund. This, too, does not always seem common practice in the infrastructure space, particularly in cases where a captive element is involved.

Overall, we as a firm very strongly believe in infrastructure as an asset class. But we would advise fund managers to put themselves in LPs’ shoes before approaching them and think their offerings through more thoroughly beforehand (rather than having to change their terms and conditions radically during fundraising).”

Anna Baumbach, investment director, Feri Institutional Advisers, Germany:

“After a huge drop in 2009, the fundraising level picked up substantially in 2010 and the 2011 outlook is also positive – although the absolute numbers remain relatively low compared with the record year of 2007.

While the fundraising environment changed substantially in themeantime, the major factors that determine the success remain the same. First and foremost, the experience, prior successes of the management team, transparent presentation of the track record and the team’s ability to create high quality deal flow are the most important elements determining the outcome of the fundraising. A well-defined strategy that meets the investors’ demand also plays a key role. For example, some clients may be more interested in stable, yield-generating investments as opposed to more risky greenfield projects.

Favorable fund terms are important, as well. Many funds approach investors with unrealistic terms in the first place which are then usually corrected over the course of the fundraising. Investors also look for flexibility in terms of strategy and fund structure. Some common examples are offering limited partners the possibility to invest in parallel investment vehicles targeting only a particular region alongside a globally investing fund, or excluding certain types of investments.

Oftentimes managers reconsider their fund structures in order to match the demand of the majority of the interested parties (especially closed-end versus open-end funds). A common mistake, made particularly by first-time managers, is to approach a broad investor base before securing initial commitments from cornerstone investors. This may create a sort of vicious circle where all investors are waiting for the one who ‘dares’ to make the first step.”