In many ways, today’s infrastructure investment market is similar to the market of 2005 to 2007. A lot of capital is being raised by closed-end funds, and the asset class is attracting interest from investors who are new to the market. But one aspect of today’s market that was missing 10 years ago is there are more clear paths not only to exit investments but also extend those investments in order to continue to benefit from a yielding portfolio of mature assets.
Today, in addition to the traditional exit at the typical 10- to 12-year life of a closed-end fund, investors can sell their interest in a fund to another limited partner investor in the secondary market, or even participate in a secondary transaction to extend the life of a fund.
“We are witnessing an increasing trend toward active portfolio management across all private markets, and the secondary market is simply a tool that investors can utilize to implement these strategic changes in allocation,” says Michael Bane, head of U.S. investor relations with Ardian. “Infrastructure assets have longer holding periods than private equity and a 15-year or 20-year term is more the norm rather than the exception. A lot can change during that timeframe; therefore, the infrastructure asset class needs a functioning secondary market to service changing investor needs and preferences over time.”
Dedicated secondary funds are raising capital and offering liquidity to investors. Blackstone, Pantheon, Ardian and and HarbourVest are a few of the investment managers currently active in the market. Other firms such as Partners Group allocate to secondary investments out of multi-strategy private infrastructure funds.
At the moment, the market for infrastructure investments is competitive and finding good new investments at a fair valuation is a challenge. Many limited partner investors might view the opportunity to remain invested in yielding assets for an extended period of time as a better option than cashing out and having to reinvest in the current market.
For those who aren’t ready to exit as a fund reaches maturity, investment managers are offering to extend the life of these funds using a particular type of secondary transaction commonly known as a “tail-end secondary” or “liquidity solution”.
Because funds can sometimes have 100 investors and their interests are not going to be perpetually aligned, secondary funds have become an increasingly popular way for investors to exit primary fund investments. These funds offer additional liquidity and replace those LPs that do choose to exit at the end of the fund’s life. But other investors can often choose to remain with a general partner–led investment fund.
“Tail-end transactions are a big part of the infrastructure secondaries market now — we estimate that 70 to 80 percent of the secondary transaction volume in 2017 was going to liquidity offerings,” says Marc Meier, senior vice president, member of the private infrastructure investment committee with Partners Group. “Real estate and private equity markets have had this type of secondary transaction for a long time, but this is new in infrastructure and a sign of a maturing industry.”
What’s driving the growth of these specific secondary transactions is the wave of fundraising in 2005 to 2007. These funds are now nearing the end of their life cycles and either have to exit investments or extend the life of the fund.
“Investors have found it difficult to put capital to work in quality assets,” says Gerald Cooper, partner with Campbell Lutyens. “Actual investor allocations have lagged target allocations to infrastructure consistently for the past 5 to 7 years. That means investors are underinvested in the space and we often see them use the secondary market to help supplement their exposure.”
In other words, despite the difficulty in finding a good infrastructure investment at an attractive value, limited partner investors continue to target the asset class, and secondary transactions and funds are one beneficiary of this demand. These “liquidity solutions” appeal to new investors to the asset class, as they offer immediate exposure to infrastructure investments whereas with a primary fund, capital can be tied up as the general partner investment manager searches for new investments.
But Meier warns investors not to get complacent about secondary transactions and investments. As these deals often involve mature, “core-like” operating assets, these positions are being acquired in a highly valued market and in an interest rate environment that is poised to rise.
“We expect the valuation cycle to return to its mean over time,” says Meier. “These investments are sensitive to changes in interest rates, and we have not had a market downturn in some while.”
He cautions investors to understand not only the assets and structures they are investing in, but also the larger market environment before committing capital.
