Alternative financing for infrastructure: liquidity in private alternative asset funds

Alternative asset funds for infrastructure provide dynamism and flexibility, claims Jeremy Bell and should be at the heart of financing discussions.

Private alternative asset funds are very flexible and bespoke structures. Little is prescribed by statute and therefore the terms are a matter of negotiation with investors. The result is that investors pool subscriptions on terms that work for them in a strategy they are comfortable with. Long term and close relationships can be formed with the manager, and an investor will have high visibility over their investments.

But all too often a drawback is a lack of liquidity. If an investor wants out, it needs to finds a private buyer for its interest or wait until the end of the fund’s term. For investors seeking regular returns, a comparison might be credit fund (investing by issuing term loans) with a total fund life of six to eight years. An equity infrastructure fund with a life of 15 to 20 years, or longer, is a different proposition. 

The attraction to many investors of liquidity terms is driven by the ‘what if’, rather than an expectation that they will need to pull the rip cord. Infrastructure assets offer attractive secure, long term and regular investment returns and a spectrum of risk/return across the different sectors to match appetites of investors. So if the investor gets their initial decision right, they should be in for the long term. A liquidity option will however give comfort where needed that the investor can get out if their needs change. 

While private funds are usually billed as 'closed-ended’, there is ample space to be creative. A fund could be structured as a hybrid so that it includes a liquid pool of, say, 20% that is actively invested in quoted infrastructure stocks. The net asset value of the fund is made of the illiquid assets and the liquid pool. Investors have the option to redeem at net asset value, perhaps adjusted to reflect exit costs. If an investor elects to redeem, its exit proceeds are sourced first from the liquidity pool. This allows for limited redemptions if needed. Clearly if redemptions amount to more than 20% (in our example) the liquidity pool would not be sufficient. Such an election could trigger a direction to the manager to sell one or more assets so as to create liquidity.  There would be a delay to redemption in that case, but there would be an expectation that within a reasonable period an investor should be able to exit. Replenishing the liquidity pool may be effected by allowing periodic fresh subscriptions at net asset value and/or realising an asset. 

In addition, or alternatively, a long life infrastructure fund could have terms for a structured exit process at, say, 10 years after launch, to bring it within a typical period for a private equity fund. On the tenth anniversary, a pre-agreed procedure kicks in under which investors have a period of time to elect their choice to ‘exit or continue'. The procedure matches appetites so that those who wish to continue (and new investors who wish to join), buy out those who wish to exit. The price would be determined according to the pre-agreed procedure and be made available to all prior to investors making their elections. An excess of leavers would be an instruction to the manager to realise assets to create sufficient liquidity or perhaps wind up the fund completely. Thus investors will know that they can exit at that point or will have the opportunity to participate in a re-formed investor base. A manager will be preparing the way perhaps a year prior to the process: engaging in discussions to ensure a smooth outcome.

In practice, these options may well never be called on for a high performing fund because any demand to exit is matched by demand to enter (on a private placement basis). But the visibility at launch of an ability to leave could increase the investor base to those who would not otherwise invest. 

Of course, there are more challenges along the way to raising an infrastructure fund and devising liquidity terms. The key message however is that private alternative asset funds offer dynamism and flexibility. They should be at the heart of any discussion on financing of infrastructure.

Jeremy Bell is a partner in the funds and asset management team at independent UK law firm Burges Salmon LLP.