EMEA: In depth: the risks and returns of style drift

04 December 2017 - 12:00 am UTC

Infrastructure fund managers are increasingly investing in assets they are less familiar with. This gives them the opportunity to earn higher returns but can also be riskier. This so-called style drift is being driven by the increasing competition for assets across infrastructure. In this latest in depth feature, Michael Dunning examines why this is happening and what the potential pitfalls might be.

The effects of the massive growth of private infrastructure investment are many and varied. While most have welcomed the influx of capital into the asset class, there been profound changes and challenges for both fund managers and LPs.

One change has been the growth of what some have referred to as “style drift”. This refers to competition for core infrastructure pushing some GPs further up the risk spectrum both to find investible assets, and make the kinds of returns they promised their LPs.

That is not necessarily a problem, but rather an example of how an asset class develops over time. However, there are some parallels with the pre-crisis bubble, and some new potential concerns.

The most obvious similarity with the heady years of the early to mid-2000s are the high prices being paid for assets, especially in the “core” area. Another is the move towards more private-equity type deals, or “style drift”. What has yet to happen are the very high levels of leverage that financed deals over a decade ago.

There are at least two potential pitfalls. The first is that LPs may have invested into a fund based on marketing claims of low risk infrastructure investments, and then find their GP is taking much more risk than anticipated. The second is that some GPs may not have the requisite skillset to manage assets further up the risk spectrum. There are some concerns in the market that, on both counts, this is happening. There is a further issue around the pressure some LPs place on GPs to deploy capital, which might contribute to riskier investments.

The alternative for GPs is that they remain in a space they find comfortable but accept lower returns for their investors.

But it must be asked whether some deals really do constitute infrastructure, which is generally regarded as a low-risk investment.

So, for example, can care homes, ferry operators and some energy infrastructure – which can have relatively high commercial risks and in some cases low barriers to entry – really be described as infrastructure? And are investments in these kinds of assets actually a problem?

What is style drift?

“There are some managers migrating out of the core space,” says Dr Matthias Reicherter of asset management firm Golding Capital Partners. “Others are staying on their home turf and accepting lower returns. And some are moving onto more complex deals in the value-add space.

“In recent times I more often have discussions with my private equity or buy-out colleagues about whether a deal might be buy-out or infrastructure. The market evolves, as do definitions, so the whole infrastructure market is shifting.”

One of the issues encouraging style drift is increasing timescales to deploy capital, which is a reality for institutional investors and some GPs. For example, a recent Invesco survey suggested that it now takes sovereign wealth funds on average four years to deploy capital in infrastructure. That is up from three and a half years, a year ago. Other investors are seeing that problem too.

Competition for assets by far exceeds the number available,” says Carlo Maddalena of APG. “Such an environment –in which institutional investors and GPs have a need to deploy capital to execute on their strategies – sets the dangerous premise for departures in investment philosophies.”  

The influx of institutional investors looking to make large direct investments in infrastructure opportunities have compressed returns and created incentives for many GP-managed funds to look at opportunities beyond the “core” space to enhance returns.

That may be for good reason, as many GP-managed funds are now no longer as well suited to the “core” space.

Institutional investors with their low cost of capital and long duration investment horizons are well suited to many of these long-term core assets.

“In many ways, this is a natural evolution of the infrastructure market,” says Stephan Grillmaier of Arcus.

“Some GPs such as Arcus have the track record, experience and sector skills to execute and manage higher return investments. But it could be more of a problem for some of the GPs that are less familiar with the more complex transactions.

Infra players are moving up the value chain, and classic private equity players are moving down because they find it increasingly harder to identify attractive enough deal-flow in their traditional space


“The infrastructure landscape is not static –for example the energy and telecom investment environments have changed significantly over the past decade. Investment strategies have changed accordingly, but GPs need to have greater specialist knowledge and effective asset management strategies to be successful.”

And competition in the “core-plus” and “value-add” spaces is also growing. “Competition is tough, but the good GPs apply their sector knowledge and experience to identify good opportunities at an early stage; often where competition is limited or absent,” says Grillmaier.

He adds that there is much more private equity competition higher up the risk curve. This is the result of two developments:

“Infra players are moving up the value chain, and classic private equity players are moving down because they find it increasingly harder to identify attractive enough deal-flow in their traditional space.”

The lack of opportunities is accentuated by the rarity of high quality assets coming to the market, says Hermes Infrastructure’s Perry Noble.

“We have been in competitive processes where we thought an asset’s investment characteristics were close to being value-add, but others have thought it was a core asset,” he says.

Such disparities are clearly a problem, and there are questions around what LPs have been promised during fundraising, and what GPs are investing in. One of the issues in this regard is related to how fees are structured, says Noble.

“You have to look at how GPs are remunerated,” he says. “Are they being paid to deploy? That can be dangerous for investors in a highly competitive market. LPs often only want to pay on deployment, and not pay commitment fees. That can create perverse incentives.”

Noble points out that the market’s trajectory has created some problems. For example, LPs are well aware of the competition among GPs for fundraising and assets. LPs also want their capital to be deployed quickly, but worry about style drift.

“LPs can be a bit schizophrenic,” says Noble. “It is up to GPs to manage those expectations.

“We need to be better at designing fee structures and incentive mechanisms. The fact that our DNA was born in private equity has distorted some of that. As the industry matures it needs to get its own systems in place to address what is a very different investment and asset class.”

One GP that is very much from the private equity spectrum of infrastructure is 3i. Stéphane Grandguillaume, partner at 3i Infrastructure’s Paris office, says GPs must adjust to their market as it develops.

“Core deals have lost about 300bps in the last four years, so it is difficult for GP with a fixed mandate to deliver what they promised four years ago. Managing a fund to adjust when the market is changing can be challenging.”

“It became extremely competitive to invest in large core infra two to three years ago, when direct investors decided to be active on such deals. Building on our strength and our PE background, we decided then to focus on core-plus assets, where we can bring more value as an asset manager. We communicated to the market on this strategic change at the time and it has been fruitful with investments in Esvagt, WIG, TCR, Valorem and Infinis.

“The market is cyclical, so strategy changes need to be well prepared and executed with discipline. It is essential that infrastructure continues to be a safe haven for pensioners’ money.”

Growth in Infrastructure Assets under Management (AuM): Select Equity Strategies (EUR, GBP, USD bn)*


MIRA Europe


EQT Partners





I Squared



Fund I

EUR 1.50bn

EUR 0.23bn

EUR 1.17 bn

EUR 1.10bn

GBP 0.10bn

EUR 0.12bn

USD 1.65bn

USD 3.00bn

USD 2.66bn

USD 5.64bn

Fund II











Fund III











Fund IV











Fund V











Fund I to latest final close





7. 33-years






Source: Inframation
* Figures are calculated based on the % increase/decrease of subsequent generation funds relative to the value of capital secured for the manager’s first fund 
** Figures are calculated based on anticipated close date and value of secured commitments


Value-add or hybrid infra

But the problem of style drift is not necessarily a new one. A decade ago, there were similar debates about what could be considered an infrastructure investment.

“Back in 2006/07 we called this hybrid infrastructure,” says Ardian’s Mathias Burghardt. “Now it is called value-add and not hybrid.”

“People keep changing the names, but the reality is that there are managers who struggle to find essential infrastructure, because they don’t have the team or access. Investing in private equity deals is a way for them to deploy money and bet for a better return.”

This hybrid infrastructure included deals such as motorway service stations and ferry companies, some of which ran into difficulties.

It is clear that style drift is occurring. What is less obvious are the forms it is taking and its possible implications. For example, the hybrid deals of a decade ago were also encumbered with high leverage. That is not the case today.

“There is a risk,” says Burghardt. “But as long as leverage remains moderate, and they invest in assets that are not too cyclical, then performance might be poor, but it won’t be a disaster like we saw in 2006.

But “if leverage is pushed up, they might lose their equity.”

Pantheon’s Andrea Echberg says the implications of style drift may not appear until there is an economic downturn or financial crisis.


…as long as leverage remains moderate, and they invest in assets that are not too cyclical, then performance might be poor, but it won’t be a disaster like we saw in 2006


“In those instances it is not just the characteristics of the asset but also the valuation and capital structure,” she says. “It’s a combination of things and you have to get that right.

“If you look at the high valuations and deals with strong correlations to GDP, then unless they have some very robust capital structures and very patient long-term investors, there may well be some problems.”

The patience of long-term investors, especially during the last downturn, was tested to the limit in some cases. Maddalena points out that the problems of style drift then contributed to APG’s decision to focus more on direct investing.

“We like to be closer to the decisions of where to deploy capital,” he says. “We’ve seen portfolios where even one bad investment can jeopardise the total return for investors.
“Retaining a consistent and rigorous approach is the most important element in principal investing, and style drift can mean taking chances and making decisions that we as an LP would never put money into.”

Noble says he is not surprised to see investments in assets Hermes Infrastructure would not consider as infrastructure, but that are sold as infrastructure. More generally, he points to the problems of overpaying for assets, over-levering them, and raising return expectations that exaggerate the economic reality of assets.

“Our job is to get the return that we say we are mandated to deliver, on a risk adjusted basis. If we can find ways on a sensible and appropriate basis to squeeze out a bit more, then we will do that, but not in a manner which adds unreasonable risk,” he says.

Noble says there is a good way to tell if an asset does not fit the traditional understanding of infrastructure: the more scope there is a for a management team to make mistakes with a business, the less likely it is to be infrastructure. The traditional sense of the term refers to it being an essential service. He adds that to avoid style drift, Hermes focuses on what its investors seek to achieve and then delivers on that.

“If we don’t do that, then we risk some kind of drift,” he adds. “We focus on investment characteristics, and do not put so much weight on sectors.”



One of the central problems around style drift is misleading LPs. Some in the market claim this borders on a kind of accidental “mis-selling”, whereby a GP markets a fund seeking certain kinds of low-risk investment but then delivers something much riskier. This can prove problematic to LPs’ portfolio construction, if they expect one thing but get another. Investors may seek to de-risk their portfolios through “core” infrastructure, with relatively low risks and single digit returns. But if they wanted higher returns, they might have opted for deals that carried greater risk in the first place.

“The key is for LPs to make sure their due diligence is thorough,” says Grillmaier. “There is no substitute for strong diligence, making sure that the skills and expertise of the teams match the investment strategy and track record.

“If you look at our investments such as Angel Trains and Shere, Arcus identified rolling stock and towers as promising areas for investment at a very early stage. We applied our detailed knowledge to validate the strength of the underlying business models and were among the first infrastructure investors in these sub-sectors.”  

These deals were not widely accepted as “core” infrastructure at the time, but they now are. Grillmaier points out that both businesses are now returning more than 20%.

Noble believes this problem will “shake out” over time. He adds that high quality managers will take a longer term view and develop products that make sense for their investors. On top of that, he says, GPs need to be patient on deployment, strict on mandate compliance, and focused on good governance.

“What we have to be careful of is losing our nerve when others around you are doing lots of deals,” he says. “Just because others are deploying or fundraising doesn’t mean you should. We have to focus on what we are doing and keep cool.

“Getting into a position where you have to deploy or raise that next dollar of capital at almost any cost can be a very uncomfortable place to be.”


The ability to manage assets

The consensus is that most – but not all – managers can move up the risk spectrum successfully.

“It is not for those who do not have experience,” says Grillmaier. “You can find infrastructure opportunities that are undoubtedly infrastructure in nature, but have more operational levers. As Arcus has demonstrated, if well managed, these can clearly generate attractive returns. But not every manager has the required skillset, even though they may believe they do.”

Grillmaier adds that asset management experience and strong relationships with portfolio company management help differentiate the managers who can successfully manage and de-risk assets.


There will be another financial crisis, and as the tide goes out people’s positions will be revealed. That will be the test. Current markets are incredibly forgiving, by allowing people to just keep kicking the can down the road


The funds with the greatest strategy shifts may be leaving their LPs more vulnerable to investments that can turn sour.

Reicherter points out that funds must be allowed to develop their strategy and move – within limits -up the risk spectrum as the market changes. However, he cautions that more radical changes in strategy might signal a problem.

“In the environment we are in, a lot of risks will materialise over the next couple of years,” he says. “Managers that want to develop long-term relationships with their LPs need to be honest and transparent about the risks.”

That sentiment is echoed by Noble: “It’s always in your best interests to act in the best interests of your investors,” he says. “But there is always a risk that the whole market doesn’t necessarily behave in that way. That invites a backlash, be that from investors, regulators or the market.

“There will be another financial crisis, and as the tide goes out people’s positions will be revealed. That will be the test. Current markets are incredibly forgiving, by allowing people to just keep kicking the can down the road.”



For now, style drift is not revealing the same problems as hybrid infrastructure a decade ago. But that is because, as Noble suggests, the market remains forgiving, and can shield managers from any bad deals.

But a downturn in the economy and financial markets could prove problematic.

“The pressure [on GPs] is definitely building,” says Echberg. “It’s very important to be selective in this market. Managers are reacting in different ways: taking more risk, bidding more aggressively, and sourcing assets from different places.”

But the extent to which GPs and LPs will be exposed will not become clear until the next financial crisis. If GPs start adding more leverage and invest in hybrid infrastructure, it may be that lessons have not been learnt.

At the same time, what makes a deal infrastructure or private equity? Can deals with significant levels of commercial risk and relatively low barriers to entry really be called infrastructure? And by calling them infrastructure, are GPs and LPs making assumptions that are ultimately misleading? Only time will tell.


Read more