In light of many recent big ticket transactions, there was an interesting debate at the 2nd annual Infrastructure Investor Australia Summit as to whether the level of local investment opportunities was sustainable.
Only those who have been living under a rock wouldn't be aware that Australia has attracted institutional capital for infrastructure investment since the 1990s. The government began privatising the utility sector (power generation and distribution) as well as other infrastructure assets like toll roads, communication and airports.
Despite the industry's perceived maturity, the continued wave of privatisation has resulted in an uninterrupted pipeline of transaction opportunities. In the last few years alone, various assets including ports (eg. Port of Melbourne), electricity transmission and distribution networks (TransGrid, Ausgrid, and Endeavour Energy) and toll roads (Queensland Motorways) were fully or partly privatised.
The 2nd annual PEI Infrastructure Investor Australia Summit recently took place in Melbourne. It brought together asset owners, fund managers, developers and global investors to discuss industry trends and share their experiences within the rapidly-growing asset class in Australia and abroad.
Sustainability
In light of many big ticket transactions, there was an interesting debate between a diverse panel of asset managers as to whether or not the level of Australian infrastructure investment opportunities was sustainable. In short, the consensus was yes, but the panellists agreed that there would be significant product development, like new assets and strategies falling within the infrastructure scope, for example the recent lease of the NSW Land Registry for AUD 2.6bn.
There was also a growing trend for managers to look overseas, including venturing beyond the OECD nations. One foreign manager also made a point on the complexity and uncertainty of gaining approval from the Australian Foreign Investment Review Board, and Australia's 'average' standing on the OECD FDI Restrictive Index. However, it was still widely acknowledged that this was not really hindering demand, and that there was much more capital chasing fewer assets, resulting in very high valuations and greater risk of compressed returns.
Evolution
Another panel discussed the changing nature of the fundraising landscape. According to Preqin data from Q1 2016 to Q1 2017 (as presented at the conference), the majority of capital for unlisted infrastructure is still raised in North America (USD$50bn), followed by Europe (USD$26bn), Asia (USD$9bn) and rest of the world (USD$6.6bn). However, the lion's share of this capital is going to an increasingly smaller number of managers, raising mega funds. According to PEI Infrastructure Investor H1 2017 Fundraising Review, 13 funds reached a final close in Q2 2017, with an aggregate raised capital of USD$ 6.6 billion, and 29 funds closed in H1 2017, raising USD$36.2 billion – the largest 5 funds closed during the period accounted for 73% of total capital raised. This potentially argues the reversal of an earlier trend of some limited partners investing directly and reverting back to managed vehicles. This may also be the catalyst for a new trend of smaller funds with more specialised strategies.
This topic definitely hit a nerve with some of the general partners at the Summit, who stressed the point that their business was no longer deal-origination driven, but increasingly focussed on their asset management capabilities. It was clear the general partner operating model was evolving. One manager explained that they now offered 'platforms' which are generally more asset-specific, targeting certain projects and on more bespoke terms than a fund, giving the limited partner greater flexibility and the reassurance of partnering with an experienced manager.
Shifting fees
One cannot expect to spend the day in a room with general and limited partners without a colourful debate on fees. Infrastructure assets have very different characteristics than other asset classes. They often provide essential services, perhaps with monopolistic market positions, creating significant barriers for new entrants and with longer asset lives - often exceeding 30 years. The investor can gain exposure to stable inflation-linked cash flows with low correlation to traditional asset classes and the potential for significant capital growth. With these traits, many of the limited partners had some very different opinions on what fees were appropriate. Some felt that 'private equity' style performance fees were not appropriate, and would not invest in any manager that was taking 20% of any excess over a particular hurdle rate. However, the majority seemed to accept the performance fees on the assumption that their net return was in line with expectations. Asset class aside, it was widely accepted that there was downward pressure on fees due to the shift from active to passive managers.
Conclusion
From a regulatory perspective, the Australian government is continuing to incentivise privatisation. It has committed to maintaining the asset recycling initiative launched in 2014 where it rewards state governments that sell brownfield assets for reinvestment in greenfield assets. Since 2008 Australia has also benefitted from the favourable 'Managed Investment Trust' tax regime. This allows qualifying foreign investors (resident of a country with which Australia has an effective exchange of information agreement on taxation matters) a reduced rate of withholding tax - 15% (versus the usual 30%) on fund distributions. Further tax reform to simplify the system is obviously desired, however in the current environment there is no shortage of interest in Australia's infrastructure assets.
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