GLOBAL - The take up of infrastructure by institutional investors is being compromised by high fees, Watson Wyatt said.
The consultant's research paper - Fees in infrastructure - said it favoured either low cost public private partnership strategies and / or higher-return value-added strategies, which are private equity-like, rather than the high-fee core infrastructure funds that currently dominate the sector.
Watson Wyatt global head of private markets research Jane Welsh said: "Infrastructure recommends itself as a natural diversifier for institutional investors and as a result it has sparked quite a lot of interest.
"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."
Watson Wyatt said most of the infrastructure funds it researched were structured as private equity-type vehicles - and had fee scales to match and are housed in complex structures.
It said there were a number of flaws with these structures, including:
- Fees based on commitments: these generate a large part of the fee-drag of investing in infrastructure and investors do not like to pay fees on uninvested cash. The report said 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 the report said it would be preferable to see management fees which reflect the budgeted costs of running the infrastructure fund instead.
- Hurdle rate of around 8%: the report said the hurdle rate should rather 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.
Welsh explained: "The structures that currently predominate in this area are obviously a good deal for infrastructure managers, but not necessarily for their investors.
"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."
Welsh added: "In the recent past, too many investors have unwittingly paid away the vast majority of the outperformance in fees.
"This is a complex area, but it doesn't mean it should be glossed over. Added rigour around fees is now leading many more managers to acknowledge that to win long-term institutional money they need to offer investors a fairer deal."
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