Caveat emptor

Why limited partner capital could be finding its way into the wrong funds.

Infrastructure Investor has been talking to a lot of professionals on the fundraising frontline in recent weeks (see our April 2010 issue for the outcome of these discussions in our fundraising special). One view frequently voiced is that pension investors know what they want. A second view that follows shortly afterwards is that this may be far from a good thing.

It’s no secret that macro-economic developments have created a climate where exposure to infrastructure is prized because of certain inherent characteristics. These relate mainly to its defensiveness in the face of volatility such as stable return streams and its ability to act as a hedge against inflation. The problem with this, the argument goes, is that some pensions are adopting very rigid views of what they are prepared to invest in based on the risk/return role they think infrastructure should be playing within their overall portfolio.

The upshot of this? Armed with lengthy check-lists relating to risk profiles, hold periods, inflation linkage, currency risk etc, managers’ strategies are under a fierce spotlight. As one placement agent claims: “Infrastructure is a very rare species in the unlisted universe, where the fund offering is being driven by investor demand”.

As a potential repercussion of this, it’s possible to imagine a fund without a proven track record successfully raising capital if it ticks all the right boxes; whereas a fund boasting impressive performance may fail if it can’t tick all the boxes.

Even if real-life examples are not this extreme, there is enough background noise on the subject to suggest that portfolio construction dogma may be taking a degree of limited partners’ attention away from rigorous due diligence on individual fund managers.

Part of the problem is that infrastructure is still a maturing asset class in which there may not be many funds offering precisely what investors are looking for. But be under no illusion: opportunists keen to raise capital in an improving but still-tough fundraising environment will be happy to step into the gap and create whatever vehicles limited partners demand.

And this should set alarm bells ringing – accompanied perhaps by a flashing neon sign displaying the words “buyer beware”. Ignore such warnings and an old adage may be exposed as inaccurate – the customer is not always right.