Institutional investors dissatisfied with funds on the market are increasingly opting to cut out the middle man and collaborate to set up their own investment funds. Fund managers who tailor their offerings to more effectively meet the needs of these investors could have a competitive advantage in the new environment. A number of Middle Eastern funds are now showing an interest in these platforms and could lead to considerable changes for investment in the region.
Why now? The financial crisis, and a series of lawsuits, reduced the trust investors had in third-party managers to protect their interests. At the same time, sustained low investment returns led many investors to focus on cost reduction – particularly in the infrastructure market, where returns are lower than in private equity.
However, direct investing brought difficulties of its own. Where a number of investors are all seeking to access the same assets, it can be inefficient for each to retain their own investment teams and carry out their own due diligence on each asset. Many investors found that the resources needed to source and manage all of their assets directly was too burdensome.
Sourcing investment opportunities also proved more difficult, because individual investors had lower profiles and fewer assets available for investment.
The next step was for the investors to pool their resources to access investments more efficiently. Many looked to the Australian model for inspiration: in particular, the pension fund collaborative established by Industry Funds Management in the 1990s.
The Canada Pension Plan Investment Board Syndicate was established in 2010 to facilitate the purchase of a Toronto toll route, with co-investors paying only their share of costs. Similarly, the Global Strategic Investment Alliance was established by the Ontario Municipal Employees Retirement System in 2012, with the aim of using the collective firepower of its members to invest in North American infrastructure.
In the UK, the Pensions Infrastructure Platform obtained regulatory approval towards the end of 2015 and a number of local government pension schemes have established co-owned funds. The Philippine Investment Alliance for Infrastructure has attracted investors from around the world, including the Dutch pension fund APG, to invest in its closed-ended infrastructure fund. A number of Middle Eastern funds are showing an interest in these platforms.
Infrastructure managers in particular should pay attention. However, the model can easily be copied for other asset classes. Forward-thinking managers will be adapting their offerings accordingly.
The reasons for the trend are complex. The cost driver was mentioned above: in the infrastructure market, there are concerns not only over the level of fees but also over the carried interest model, which incentivises the manager to sell the asset where the interests of the investors lie in holding it for the long term.
Institutional investors are also paying attention to governance and transparency. Funds offering a partnership-based approach to governance, with managers taking the investment decisions within a framework that allows investors to set parameters on the manager’s discretion, will be particularly attractive to investors.
The smartest managers will be looking to work with the new collaboratives to create models that benefit all involved.
Judith Donnelly Partner, Squire Patton Boggs
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