Why smaller infrastructure fund sizes with mid-market focus versus large funds are appealing

When discussing infrastructure investment opportunities with potential investors, they often prefer large funds over mid-market transactions.

There is a lot to be said about this, which is why investors would do well to take a closer look at opportunities in the mid-market segment.

1. Expected Returns

Expected returns are higher, as (i) the market for the (mid-market sized funds) is less crowded than the (large-sized) market the more considerable funds are targeting, (ii) Typically smaller infrastructure funds are in a position to work on transactions before they hit the market and therefore have a head start in the transaction and face less competition on price than with competitive auctions and (ii) well-established funds have the team, the experience and capabilities to develop projects from the start of construction throughout operations, thereby creating a value inflection point, rather than just buying operational assets. (The opportunity to create value is more significant). The higher returns are not generated from a higher risk profile but from the fact that the manager puts in a lot of hard effort and work.

2. Risk

Risk is lower as dedicated smaller funds spend a significant amount of time (as opposed to money) in developing the opportunity and structuring the deal, including setting up the underlying contracts (construction, operations and maintenance, supply, off-take, etc.). The investment team often has lengthy discussions with various stakeholders (in both the private and public sectors) before an investment opportunity becomes concrete. The risk profile is, therefore, actively structured by the team to fit the fund, as opposed to a more standard approach where a fund performs due diligence on a given structure and risk profile to assess the opportunity. Also, risk profiles are not a linear equation. The larger projects become, the more complex they get, and more points of failure can arise.

3. Contract Terms

The contract terms with the developers are better through the manager's active involvement, experience, and the fact that he develops trusted partnerships. In return, the hands-on approach also adds value for the developer/vendor in creating and growing the opportunity. Combined with the work the manager puts upfront in structuring the transaction and contracts, the terms are better, resulting in a lower risk profile for the same or better returns.

4. Capital Deployment

Larger funds are under pressure to deploy capital. Due to the size of more significant funds ( > 1.5bn euro), they are pushed towards more effective transactions. The number of available deals for these more considerable funds is limited compared to the amount of capital deployed worldwide. Combined with time constraints in the investment horizon of these funds, it puts much pressure on them to deploy capital, thereby driving up prices and/or increasing risk tolerance and reducing return capabilities. We see this in the larger infrastructure transactions where significant funds compete against each other but sometimes even have different strategies. This is due to the scarcity of deals and the abundance of capital. Fortunately, the market that smaller funds serve (mid-market) and the fact that such funds have a significantly large pipeline compared to the expected fund size allows smaller managers to invest in the projects they believe are the right fit and reject transactions that they think are not favorable in terms of risk and/or return.

An example of such a mid-market fund is EPICo II. The EPICo II fund (Article 8 Fund*) is a diversified and balanced portfolio of European greenfield and operational infrastructure assets such as Energy Transition, Digital Transformation, Social Infrastructure, and Sustainable Mobility and Transport.

*An Article 8 Fund under SFDR is defined as “a Fund which promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.”

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