Several trends have combined in recent years to create significant new opportunities in the Middle East and North Africa (MENA) region for investors in infrastructure. The most important of these trends are related to demographic change, strong economic growth, surging government spending and a willingness on the part of governments to explore private-public partnerships in key areas of economic and social infrastructure.
Internationally, USD 40 trillion of infrastructure investment is expected by 2035. According to the Preqin Global Infrastructure Report 2012, in January 2012, 44 infrastructure funds were fundraising, targeting commitments of USD 93.2 billion. In relation to the MENA region, although it is still a young asset class, a growing number of MENA-focused infrastructure funds have been raised or are being raised to take advantage of these opportunities. Most of these funds adopt a private equity-style model and invest essentially in "greenfield" developments as opposed to established "brownfield" assets.
The argument in favor of private sector involvement in infrastructure is compelling. Where government spending is constrained, private capital frees up public funds that can then be diverted to other priorities. Governments can also transfer development and performance risks associated with new infrastructure projects to the private sector. In addition, the involvement of an experienced fund manager generally reduces the time and cost of developing new infrastructure and creates the proper incentives to improve services and maximize efficiency.
Just as governments in the MENA region have started to understand the advantages of attracting private capital, investors such as pension funds, endowments, sovereign wealth funds and development finance institutions have shown an increasing appetite to invest in infrastructure. These investors recognize the obvious advantages of investing in infrastructure assets which, in the case of "brownfield assets", include, lower volatility, access to stable long term cash-flows and a value-creation process that is less influenced by management and less dependent on market cycles.
While infrastructure investing share attributes of private equity, real estate and fixed income assets, it probably lays somewhere in-between existing allocations for most institutional investors. This creates both challenges and opportunities for fund managers. The key challenge, especially in an emerging market like MENA, is explaining this asset class to new investors and agreeing fund terms.
Considering the complexity and proprietary nature of most "greenfield" projects, it seems appropriate that fund managers should be rewarded for the hard work needed to source and execute such deals. At the same time, it is critical that manager's financial incentives be properly aligned to the interests of investors.
Internationally, infrastructure funds tend to have commercial terms that are very similar to mainstream private equity funds. These terms include a fixed life of 10 to 12 years or more, a management fee based on committed capital and "carried interest" which is payable on the condition that investors receive an agreed minimum rate of return. In addition, most private equity funds are organised as "blind pools" which allow the manager to drawdown investor capital for any purpose consistent with the fund's investment policy.
For decades, the private equity fund model has worked well to align with interests of fund managers and investors. At times, industry groups such as the Institutional Limited Partners Association have proposed guidelines to improve alignment and ensure proper governance, but their intent is always to improve the basic model not to replace it with something different. According to a survey of 60 leading institutions by Preqin, the top three pressure points are management fees, step-down in management fees, and carried interest.
As infrastructure investing picks up steam in the MENA region, fund managers and investors would do well to learn from the private equity industry and adopt structures and terms that have worked well in a similar context. Adjustments may be needed to account for the longer holding periods of certain infrastructure assets. However, in the end both investors and managers can be assured that there are market-standard terms and conditions which have proven their worth for decades. Applied well, such terms can form the basis of a long-term, balanced and profitable relationship.
© Zawya 2012
