KFH Research Team pose for group photo
Sovereign funds prominent investors in infrastructure assets Sentiment laced with caution over short-term

A report prepared by KFH-Research regarding the performance and status of global infrastructure funds market, mentioned that despite the recent poor performance of subscriptions and money gathering, infrastructure funds are expected to attract more investors and to continue achieving reasonable growth; especially after the growing trend to spend funds on in infrastructure projects and the participation of the private sector in those projects. In addition, the report noted that infrastructure funds began to recover starting from 2010, where total collected money reached $32 billion, before dropping to $16 billion in 2011. The report expected to have the same value this year, which is $16 billion, and mentioned that sovereign funds, especially in the region, are the most prominent investors in infrastructure assets. — Editor

The purpose of the report is to provide an insight into the performance, investors, deals, and fundraising in the infrastructure fund market. In 2010, the unlisted infrastructure sector grew strongly resulting in over $30bln being raised by funds that closed in the year. However, the growth in the market stalled in 2011 as funds closed in the year reached around half of the amount raised by funds closed the previous year. We believe the factors that hindered growth in 2011 will still apply in the coming 12 months, enhanced by the extreme levels of economic uncertainty around the world. However, with a record number of funds on the road and increased public reliance on the private sector as a source of capital for infrastructure development, it seems likely that the market will continue to grow over the longer term.
Infrastructure Fundraising
In 2011, 28 unlisted infrastructure funds reached a final close having raised an aggregate $16.1bln. While this represented a 49% decrease from the $31.8bln raised by infrastructure funds closing in 2010, it was still 85% higher than the capital raised by funds closed in the midst of the financial crisis in 2009. The average fund size for funds closed in 2011 was $575mln, lower than the $776mln in 2010 but again higher than the $414mln average in 2009. Despite this dip in annual fundraising, a further $13.1bln in fresh capital was raised by funds holding an interim close in 2011, showing good momentum in the fundraising market moving in to 2012.

A consequence of the financial crisis is that investors are now far more selective when committing capital to unlisted infrastructure funds. However, despite decreased activity during and after the crash, the prevailing sentiment within the industry was one of short term caution rather than a complete abandonment of the asset class. As such, investor confidence remained strong in 2011, with many institutional investors indicating they will continue to invest capital, both in 2012 and over the longer term.
A survey by Preqin showed that a significant 62% of respondents in their mid-2011 investor study planned to make infrastructure fund commitments in the following 12 months, while a further 6% planned to make direct investments and 2% would make co-investments. Of those that planned to make future fund commitments, 22% expected to invest on an opportunistic basis while 20% expected to make multiple fund commitments. A further 8% remained undecided and expected to finalise their investment policies in 1Q2012.
In the same survey, investors’ plans for infrastructure investment over the long term showed that only 9% are unlikely to invest in the asset class moving forward, while 62% of respondents are planning to continue investing in unlisted infrastructure funds. The remaining respondents are planning to either make investments directly or will look to gain exposure via co-investments.

Although fundraising slowed in 2011, current investor sentiment suggests that infrastructure fund investment remains an attractive proposition for institutional investors, with infrastructure assets increasingly becoming a distinct feature in a typical investment portfolio. Furthermore, the balance of power between investors and fund managers when negotiating terms and conditions has shifted towards investors somewhat in recent years, meaning fund managers will have to ensure that their terms, especially those relating to management fees and carry structure, satisfy investors if they are to be successful in this increasingly competitive fundraising market.

Sovereign Wealth Funds
In recent years, sovereign wealth funds have also begun to play an increasingly important part in the infrastructure investor landscape, gaining significant exposure through both infrastructure funds and direct investments. Infrastructure assets appeal to sovereign wealth funds as they offer the potential for steady, inflation linked cash flows over long time periods. Sovereign wealth funds have grown their aggregate assets under management (AUM) significantly since 2011, reporting an increase of 16%. Asia and MENA are home to the largest numbers of sovereign wealth funds, and account for 54% of these institutions between them. Furthermore, funds based in the two regions make up more than three-quarters of the aggregate value of all such institutions worldwide. This is unsurprising given the fact that Asia and MENA are home to two of the three largest sovereign wealth funds in the world, and many other large sovereign institutions beside that.

The popular areas for infrastructure investments by sovereign wealth funds are Asia and Europe. Approximately 45% of sovereign wealth funds that invest in the asset class target opportunities in Asia, with the same proportion having a preference for Europe. In comparison, 42% seek infrastructure investments in North America, while MENA is favoured by 32%. The majority of the sovereign wealth funds investing in the MENA region are domestic investors such as Dubai International Capital and Abu Dhabi Investment Council, which have an emphasis on domestic development. In the last year there has been a marked increase in the number of sovereign wealth funds targeting global infrastructure investments. At present, 52% of the sovereign wealth funds investing in infrastructure target global investments, a significant increase on last year’s figure of 41%. This desire among sovereign wealth funds to acquire a globally diversified infrastructure portfolio suggests that whilst many of these investors historically gained exposure as a means of aiding development in their home nations, now more and more are seeking infrastructure assets for the value they can add to an investment portfolio.

Deal Flow
The number of deals finalised by unlisted infrastructure fund managers grew steadily between 2004 and 2008, which mirrors the growth in fundraising experienced during the same period. In terms of the number of deals completed, 1,634 separate investments have been made by unlisted infrastructure fund managers since 2004. Deal flow peaked in 2008 with 275 transactions completed during the year, but has since plateaued due to the impact and on-going effects of the financial crisis and recent economic uncertainty. Investment in infrastructure assets typically requires a significant amount of leverage. It is therefore unsurprising that infrastructure deal flow has struggled to grow in the immediate years following the crisis, despite positive growth in the fundraising market.
Fund managers continue to find it tough to source and negotiate profitable deals due to a lack of long-term debt financing and the increased cost of borrowing. Two hundred and twenty-four deals were executed by unlisted fund managers in 2011, a figure that is expected to rise as further information becomes available. This number is however unlikely to significantly exceed the 256 deals completed in 2010.

The road ahead for the infrastructure asset class appears positive. Although 2011 fundraising levels fell short of those achieved in 2010, much of the capital raised was fresh investor capital committed over the past 18 months. A further $13.1bln was raised by infrastructure funds holding an interim close in 2011, showing that institutional investor appetite for such vehicles remains strong. This, coupled with a growing demand for private sector investment to aid in the development of public infrastructure, suggests that the market will continue to grow in future.
However, with the majority of funds on the road having been launched since the financial crisis, the fundraising market is largely comprised of new vehicles targeting lower and more realistic levels of capital. Institutional investors will remain cautious in 2012, meaning these funds are likely to be on the road for some time and hold several interim closes before reaching a final close. It is therefore unlikely that 2012 fundraising figures will rise significantly beyond those achieved in 2011, if at all, as both investors and fund managers continue to adapt to life in the post-crisis marketplace.

We also expect infrastructure will remains an important asset class for sovereign wealth funds due to the intrinsic characteristics of the assets and the overall strategic goals of many such institutions. We expect these institutions to continue committing capital to the asset class, both domestically and globally, through direct investments and commingled infrastructure funds moving forward.
Encouragingly we are also seeing a greater number of sovereign wealth funds aiming to create globally diversified infrastructure portfolio, representing a change in focus from a pure developmental infrastructure investment strategy to a twin strategy pursuing infrastructure assets for diversification and stable investment returns.

By: KFH Research Limited

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