From a structuring perspective, infrastructure funds are most frequently established as either a limited partnership or a limited company. Partnerships are the familiar vehicle for private funds, whereas companies will be used for listed vehicles. Obviously there will be nuances depending on the asset class and the type of investors being targeted. Limited companies can have characteristics that resemble a limited partnership – particularly in offshore jurisdictions such as Guernsey – but generally it will be one of the two options described above.
There are some inherent difficulties with infrastructure funds, given the incubation period for setting up these vehicles. Ideally, investors want the fund vehicle to have a seeded portfolio in place or, at the very least, identified target assets – they want to be confident that the capital will be deployed and, particularly in the case of listed funds, that their investment will not be subject to extended cash drag.
However, not all managers can come to the table with a book of seed assets which are lined up and ready for investment by the new fund vehicle.
This creates a bit of a catch-22 for many of these funds. How can investment managers balance investor expectations regarding capital deployment with the need for a long enough runway to identify the right assets? Time is not always on their side.
Some have fallen down because of the difficulty of raising a book of capital from investors, given that the investment period may potentially be over multiple years. As such, identifying and vetting investments takes time – this is one of the reasons why the largest infrastructure funds tend to launch in the private space.
While there are some notable listed infrastructure funds, it remains easier to raise a private infrastructure fund, given the ability to draw down commitments gradually and because of the investment size that investors prefer to make.
Private funds generally raise higher amounts of capital than listed funds. In a limited partnership arrangement, a private fund provides the ability to use capital calls and draw-down capital as and when required, whereas a listed fund must have all of its shares fully paid up before listing on the London Stock Exchange (LSE) or elsewhere.
A listed fund can potentially invest in a single or limited number of infrastructure assets, thereby making it easier to put the capital to work, but the difficulty with this is that the fund may not be considered suitable for listing in the eyes of the listing authority.
The regulator will expect to see a spread of investment risk for a premium listing on the LSE and that the portfolio comprises a sufficient number of assets. Investors will be looking for disclosure on the nature of those assets in the prospectus. Fortunately, there are alternatives in the form of the Specialist Fund Segment of the LSE's Main Market for vehicles which will invest in fewer assets or may not satisfy all of the rules comprising Chapter 15 of the UK Listing Authority's Listing Rules.
By comparison, those considerations may be seen to fall away for a private fund. The spread of investment risk will be for the manager to determine (based on the investment proposition agreed with the limited partners), not the listing authority by reference to the relevant rules.
Given the sheer depth and breadth of infrastructure projects to choose from, it is understandable why, when looking to launch an unlisted fund an investment manager might want to attract what are known as 'blind pool' investors. In short, these are investors that commit to investing in a vehicle with no seed assets or identified target assets. However, this is a much harder sell.
Unless dealing with a particularly high-profile fund manager with an extensive track record, investors will want to know upfront what the portfolio is expected to be composed of. If the infrastructure investments are in an area of the market where there are significant investment opportunities, investors may be more likely to invest blind. It could be that the fund itself does not invest directly in infrastructure, but rather is exposed to the asset class – for example, a fund-of-funds.
It is clear why a listed vehicle would be attractive from a manager's perspective. The listed vehicle provides the investment manager with permanent investor capital to seed a portfolio of private infrastructure funds. Getting the seed capital and the initial traction is critical, after which it becomes easier to attract other investors.
Aside from the sheer number and variety of infrastructure projects, another element of complexity that managers must consider is the regulatory and political vicissitudes of the countries in which they invest. This creates a range of potential risks. For example, investing in a wind farm might be predicated on the operator selling electricity at a particular price, which could be affected by regulation. Infrastructure projects in the energy sector will require significant diligence by fund managers.
For private infrastructure funds investing in the energy sector, there will likely be added regulatory complexities that could increase costs for the fund; especially if it requires working with advisers, lawyers and specialist valuation agents in local markets. These are specialist investments; investors will want assurances that their capital is protected and being managed appropriately.
To that end, the more successful infrastructure fund managers are those with well-developed networks of experts spanning the target markets in which they wish to invest. Having local expertise and knowing how to handle idiosyncratic risks, both political and regulatory, is a vital consideration for any institution when assessing with which managers to invest.
In terms of structuring a private fund, the most frequently used option is to have a limited partnership where a group of investors bands together as limited partners under a partnership agreement.
The general partner of the partnership then appoints the investment manager. This is the tried and tested model and is generally no different for private equity and real estate funds.
As limited partnerships will not typically have a legal personality, they should be taxed on a look-through basis.
The team structuring a new vehicle will look to minimise tax leakage within the fund structure, which one of the reasons why fund promoters are heading to Guernsey. The aim will be for investors to be taxed principally in their home jurisdiction.
Further, structuring teams will look to take advantage of jurisdictions with good double taxation networks, as well as those jurisdictions which are familiar to investors.
The ultimate structure of a fund will depend on a combination of factors:
- where the assets are located;
- where the investors are based; and
- how investment will be structured.
An earlier version of this update first appeared in Global Fund Media's May 2017 special report "Investment opportunities in infrastructure debt".
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