How Real a Threat to Infra Funds is the Direct Investing Phenomenon?

By Andrew Cavenagh

Recent infrastructure auctions have resulted in pension funds and insurance companies outbidding infrastructure funds in order to win prominent infrastructure assets.

In 2010, an Ontario Teachers’ Pension Plan (OTPP)/Borealis alliance won the 30-year concession to operate the high-speed rail link between London and the Channel Tunnel (High Speed One). In April this year, a venture between CNP Assurances, a French insurer, and CDC Infrastructure (the Caisse de Dépôts subsidiary) secured a 25% holding in the GDF Suez gas grid in France with a bid of EUR1.1bn. And earlier that same month, two of Denmark’s largest pension funds – PensionDanmark and PKA – invested over EUR800m for a 50% interest in one of Denmark’s largest wind farms.

Deals like those have raised the question of whether infrastructure funds can be competitive with pension funds – and other institutional investors – that choose to make direct investments in the infrastructure asset class.

While a handful of the largest Canadian and Australian pension funds, such as OTPP and Borealis, have been making direct acquisitions in the utility and transport sectors for several years, most retirement schemes have historically preferred to obtain exposure to the asset class via GP managed funds that would select assets on their behalf.

But that’s changing.

“Pension funds are now right there in the firing line alongside the infrastructure funds,” said one banker with a long track record of providing the debt for such acquisitions. “You find that they’re coming in much more now at the primary stage.”

One of the reasons for that is their lower cost of capital.

The threat pension funds – and other institutions like sovereign wealth funds – pose to infrastructure fund managers is very real. They have significantly lower costs of capital – around 7%-8% against the 10%-12% that infrastructure funds typically offer their investors. They also have longer investment horizons. In the case of recent infrastructure auctions, like High Speed One, both those points enabled them to table higher bids.

“In certain cases they [pension funds] are able to base their bids on a lower equity rate of return,” explains Nick Bliss, a partner and co-leader of the global infrastructure and transportation group at the law firm Freshfields. “Direct investors seem to have had a bit of an upper hand in the very large infrastructure auctions in the UK over the last year or so.”

Drivers for Change
One driver of this increase in direct involvement has been a growing reluctance on the part of pension funds to pay the fees that infrastructure fund managers charge. While fees have come down over last two years (with management charges now around 1% rather than the 1.5%-2% that they were previously), many pension funds remain sceptical that they represent value for money.

“There was certainly a question being asked by the pension funds as to the value they were getting for the size of fees they were being charged,” says Bruce White, head of global project finance and the infrastructure and energy team at law firm Linklaters. “So some of them have consequently decided to do it for themselves.”

Having cut their teeth on infrastructure investments through the first generation of infrastructure funds, more pension funds have become sufficiently familiar with infrastructure as an asset class to adopt the direct approach. This has been especially true in jurisdictions such as the UK, where there is a long history of private sector involvement in all types of infrastructure. Also bidding for the High Speed One asset were the Universities Superannuation Scheme (USS), a UK pension scheme, ADIA, a sovereign wealth fund, PSP Investments, a Canadian pension plan manager, and Hermes, a fund management company owned by the BT Pension Scheme.

At the same time, infrastructure funds have also faced a resurgence of interest from large trade or industrial buyers.

The sale of the UK power distribution networks of both EDF and E.ON to such buyers, CKI, a Hong Kong-based diversified infrastructure company, and the US power group PPL Corp, respectively in July 2010 and March 2011 were illustrations of that trend, which has further increased the pressure on infrastructure funds in such auctions.

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