The most notable development in the infrastructure secondaries space in the last two years has probably been the emergence of liquidity offerings, or tail-end (GP-led) liquidity solutions, which have been driven by the different expectations of existing LPs in established funds with fully formed portfolios, and by the desire of new groups of investors to enter the asset class.
From the perspective of existing investors, a number of LPs that committed to the ‘first-generation’ infrastructure funds in 2006-09 have a strong expectation of the liquidity events coming through, as the funds approach the end of their originally set terms. The preference for liquidity is explained by the fact that some investors (for example, certain banks that were significant LPs back in 2006-09) discontinued their engagement in the asset class and other investors changed their approach (for example, many large pension funds established direct infrastructure investment programmes).
Not all LPs are targeting liquidity in their infrastructure portfolios. Certain LPs tend to be more interested in maintaining their exposure to the asset portfolio, perhaps because there is a lack of investment alternatives in the current market environment, or they desire to eliminate friction costs created through the sale and purchase of assets, or because they prefer yield over capital appreciation typically generated by asset sales (bearing in mind that building a yielding portfolio usually requires substantial time). In addition, in certain occasions, extending the holding period can maximise value recovery for those assets that were highly levered at entry and therefore disproportionally impacted during the global financial crisis.
Based on those considerations, a number of managers have launched organised processes with the view to providing liquidity to LPs without necessarily selling the underlying assets. Although these transactions are usually seen in the secondaries context, it is worthwhile noting that they exhibit the following different characteristics to the typical secondaries transactions:
- Longer duration, sometimes as long as 25 years
- Typically, no upfront discount to NAV
For those reasons, such transactions might be challenging for the players with typical closed-ended funds seeking to front-load infrastructure returns via secondaries transactions.
An additional benefit of an organised tail-end liquidity solution is the opportunity to restore the alignment in the group of investors and to secure a group of LPs willing to support the GP and the fund over the long term. On many occasions, these transactions also serve to rebalance the economics for the GP by:
- adjusting the management fee to a longer asset management period with limited asset selection, due diligence and execution work;
- re-basing the performance fees from acquisition costs to the most recent fair valuation marks; and
- occasionally crystallising the payment of the performance fees
While tail-end liquidity solutions serve valid purposes and are usually conceived with the aim of satisfying the needs of the different participants, they inherently pose a number of conflicts, which need to be carefully managed. Here are just three of the possible conflicts that can arise:
- The GP often acts on both buy and sell-side. GP interests, on many occasions, are more aligned with the remaining (and incoming) investors, which are poised to support the GP in the future, as opposed to the exiting investors. Especially, in cases where no performance fees can be crystallised after the initial period, the GP can be less interested in maximising the price of the liquidity offering, as a higher price would translate into a higher base for computation of performance fees for the extension period.
- The information disclosure in a tail-end liquidity solution process is often less granular than in a ‘normal’ asset disposal and, as such, can result in less value obtained compared to an organised asset sale. In addition, secondaries buyers could (and to some extent should) expect better pricing versus a direct asset acquisition to account for the more complex structure, less control over the asset and value impact of the GP
- The typical control mechanisms present in the fund investment environment are less relevant for the tail-end liquidity solutions. For example, key-man clauses leading to a suspension of the investment period are not really applicable to the fully built out portfolios.
All in all, the complexity of tail-end liquidity solutions and the need to carefully navigate different conflicts result in a fairly small number of those processes effectively reaching completion. As mentioned before, we expect three or four funds to achieve completion on the liquidity solutions in 2016. Probably, the most widely publicised transaction of this type is the sale of 21 LP interests in the 2007 vintage €2.17 billion Arcus European Infrastructure Fund totalling over €700 million.The transaction was led by APG, the Dutch pension fund manager, which acquired a €440 million commitment out of €700 million sold.
Other advanced liquidity solution situations that were expected to reach completion in 2016 involve a potential portfolio transaction involving eight assets in the 2007-vintage €1.1 billion Eiser’s Global Infrastructure Fund (for which 3i Infrastructure and APG were bidding) and the establishment of a continuation fund for the 2010 vintage €572 million Dutch Infrastructure Fund II.
Even within the limited universe of infrastructure secondaries players, only a few are capable of leading a tail-end liquidity solution. Besides the ability to evaluate a secondaries transaction, such a role requires a significant amount of capital (typically, at least between €100 million and 150 million is necessary to act as a cornerstone investor), the ability to lead a complex documentation process and, more importantly, the appetite to lock in capital for a period of up to 25 years. The latter requirement, in particular, cuts across the expectations of secondaries investors, which often focus on providing early cashflows from an infrastructure portfolio and have underlying investment vehicles with a life span of 10 to 15 years.
Dmitriy Antropov is senior vice-president of private infrastructure at Partners Group and co-leads the firm’s worldwide integrated infrastructure investment activities, which include primary and secondaries fund investments, as well as joint investments. He has been with Partners Group since 2008 and has 12 years of industry experience. Antropov holds a PhD in world economics from Financial University in Moscow. He is also a certified financial risk manager.