The current fee structures featured by many infrastructure funds are flawed and are impeding take up by institutional investors, according to Watson Wyatt. However, with a few changes, such funds may see a sharp rise in investor interest.
Watson Wyatt’s Fees in Infrastructure report concludes that the firm favours either low-cost PPP (public-private partnership) strategies or higher-return value-added strategies, which are private equity-like, rather than the high-fee core infrastructure funds that currently dominate the sector.
“Infrastructure recommends itself as a natural diversifier for institutional investors and as a result it has sparked quite a lot of interest,” says Jane Welsh, global head of private markets research with Watson Wyatt. “However, many of the infrastructure funds that have been set up in response to this demand will be of very little interest to our clients until we see more attractive fee packages.”
The report reveals that most of the infrastructure funds Watson Wyatt researches are structured as private equity-type vehicles with fee scales to match and are housed in complex structures. It offers the following observations:
Fees based on commitments
Fees on commitments generate a large part of the fee-drag of investing in infrastructure and investors do not like to pay fees on uninvested cash. Rather, fees should be based on invested capital in most cases.
High management fees of 1% to 2%
In many cases infrastructure managers see the management fee as a major source of profits. However, it would be preferable to see management fees that reflect the budgeted costs of running the infrastructure fund instead.
Hurdle rate of around 8%
The hurdle rate should reflect the particular investment strategy and ensure the manager only earns a performance fee if they genuinely add value
Carried interest of 20% and catch up
This is not unreasonable if the hurdle is a genuine hard hurdle with no catch up. However, a significant proportion of the carried interest should go to the team managing the fund rather than to the parent company
Additional fees and charges
Infrastructure managers should not make incremental charges like transaction or financing fees, this should be covered by the management fee.
“The structures that currently predominate in this area are obviously a good deal for infrastructure managers, but not necessarily for their investors,” says Welsh. “While we strongly believe in fair compensation, these fee structures are currently too high for the value they deliver, particularly in a lower-return environment.”