EMPEA special report: Private Investing in the Power Sector in Emerging Markets
Investor Perspectives: Fund Structures and Power Project Development
The lifecycle of power assets is important to understand for any investor looking to get involved in EM power. The longevity of many power assets, in particular, calls attention to a key underlying question: is a fund structure the best way to invest in the sector? For greenfield investors in particular, the challenge of building and exiting an infrastructure asset within the parameters of a fund’s life, which is generally much shorter than 20 years, is immense. In this regard, the reality of the development process for power assets is an important consideration for institutional investors with shorter investment horizons. Commenting on this, Reyaz Ahmad, Chief Investment Officer and Head of IFC Catalyst Fund at IFC Asset Management Company, says, “Since the development risk of earlier stage investments can lead to long gestation periods, fund managers that focus on this stage in the development cycle of a project can prove challenging for an investor. As a fund of funds, some early development projects might have made sense for us earlier in our fund’s life, but it’s difficult to assess and time the probability of the managers returning capital to us.” While fund managers may face pressure to invest and exit, for some investors, selling assets may not even be appropriate given their desire to match long-term liabilities with equally long-term assets. A fund vehicle brings a familiar, approachable investment structure in which institutional investors are well versed. But the limitations of this structure are accentuated in a power context.
Mounir Guen, CEO of global placement agent MVision Private Equity Advisers, highlights that the characteristics of operational power assets that make them attractive in the first place may lead LPs to consider alternatives to the traditional fund model: “The return profiles of real assets are very attractive. These are yield-producing, long-term assets. It’s a dream for pension plan sponsors, but ultimately, investors want to be able to hold these assets for 15, 20 or 25 years.”
Some GPs have begun striking arrangements under which they “manage out” an asset on behalf of their LPs for a longer term beyond a fund’s life, but this model has not yet been widely adopted. In the end, assessing the likelihood, timing and even the desirability of an exit is important for any LP looking to gain exposure to this opportunity-laden asset class.
Investor Perspectives: Risk
The risk-return proposition for LPs investing in power infrastructure is influenced by many factors, and unpacking potential risks for investors can be helpful in accurately assessing various portfolio exposures.
According to Mounir Guen of MVision Private Equity Advisers, especially in a sensitive sector like power, LPs will ultimately back fund managers who provide transparency into underlying risks. Guen explains: “In an environment where governance, transparency and communication are essential, the ability for a fund manager to convey risks to LPs is very important. If you can show me how I can understand the risk to my money, and I can see that you have governance in place to manage or mitigate those risks, then I’ll take the risk.”
This risk-return proposition is already quite familiar to any GP operating in emerging markets, as factors like political risk can be major deterrents to LPs. For traditional private equity, many LPs thus expect a “return-premium” from their EM private equity portfolios, and this is no different for power investments. According to one U.S.-based public pension fund investment officer, “We always think in a risk-adjusted framework; I should get a higher rate of return in EM power than developed markets power, or it doesn’t make sense to pursue.” For GPs, finding and presenting investible opportunities that mitigate risk can go a long way in securing commitments. The public pension fund employee confirms this, saying that, “If fund managers are able to mitigate a lot of the risks, then they do a pretty effective job in our estimation. While there is some diversification benefit from power investing from a portfolio standpoint, a big part of making the capital commitment comes from the risk mitigation.” To GPs, presenting a fund opportunity in risk-adjusted and transparent terms can play an important role in facilitating commitments.
The power sector in emerging markets (EM) is increasingly on the radar screens of international investors. Demand for electricity in developing economies is high and will only grow, requiring substantial additional investment in both the modernization of outdated power infrastructure and in building new capacity in order to meet the needs of consumers and businesses. As this report uncovers, electricity supply and demand dynamics in emerging markets—coupled with regulatory environments that have evolved towards increased private participation in the power sector—underpin an opportunity for private investment fund managers (GPs) and their limited partners (LPs) to not only earn compelling returns, but also drive further economic growth and welfare gains by increasing access to reliable and affordable power.