Infrastructure funds are growing up fast. Ten years ago, in the first half of 2011, seven funds raised around USD 3bn. This H1, it was 31 funds bringing more than USD 50bn to final close. It looks likely that this full year will exceed USD 100bn in total fundraising, for the first time ever.
Yet one thing is not changing: GP hurdle rates. A traditional hurdle rate of around 8% or above has brought thousands of new LP investors into the asset class. But with so much competition among funds to invest, this figure is becoming dangerously out-of-sync with what can be achieved in the market we now see.
Net returns are generally considered to be between 7% and 10% for core infrastructure such as roads and power grids; core plus investments (car parks or data centres) are 10%-13% and higher-risk value-add investments start at 14%. Anything above 20% is “exceptional”, says a placement agent.
But according to Inframation data, average achieved net returns exceeded 8% in one year in the period (2015) and in some cases these funds were targeting up to 15% (almost double the standard hurdle rate of 8%).
Of course, early movers into value-add infrastructure and big brand managers with private equity experience have far exceeded these figures in many cases but the reality for many infrastructure GPs on the ground is now a tale of dry powder, yield compression and asset scarcity.
Many are worried that return expectations have been stretched too far by a small group of successful funds and that they will have to move further up the risk curve to satisfy their LPs.
“I'm telling this to our LPs, our investors, just saying: ‘that fine print at the bottom of every presentation, which is past performance, read that carefully. Think about that – the market has changed’,” says a fund source.
With competition for assets driving up valuations, European renewable energy funds with a hurdle rate at or above 8% (and infrastructure GPs investing in operational wind and solar farms) face a wake-up call on what they can actually achieve in the years ahead.
“No-one in their right mind will tell you that [target returns] will increase in the short term. We know they are decreasing,” says the fund source. “It should decline towards 6%.”
The two largest funds raised so far this year – Copenhagen Infrastructure IV (USD 8.3bn) and BlackRock Global Renewable Power Fund III (USD 4.8bn) – were both renewable energy funds. Marketed as a “climate infrastructure fund”, Blackrock is targeting net IRR of 9-11% and CIP is targeting 11%.
But while Blackrock is the largest money manager in the world with a sprawling, experienced team and CIP has an enviable track record for taking development risk on projects, other smaller GPs do not share such advantages. They will need to find some, and fast.
For more on this topic, please read the News Analysis published by Inframation here
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