Open-End Funds: Time is Money in Infrastructure’s New Era

Historically, many infrastructure companies such as utilities, airports, and toll roads exhibited stable, low-growth earnings. However, the investment landscape and its growth opportunities have broadened significantly. The transition to low-carbon economies, the digital infrastructure boom spurred by Generative AI, and the rewiring of supply chains to counter geopolitical tensions have expanded the scope of investable infrastructure. These changes offer vast potential to transform industries, consumer behavior, and economies. “Next-generation infrastructure” is at the center of these transformative waves, in particular across transportation systems, renewable energy, and communications networks.

As the infrastructure asset class grows, its entry into the mainstream will deliver substantial capital flows as institutional allocations increase. This influx of capital underscores the need for diligent fund structure decisions. Fund structures must align with the nature of the assets and business plan time horizons of portfolio companies. Choosing between closed- and open-ended funds is crucial to optimize investment strategy execution and fully capture the potential of “next-generation infrastructure investments. Optimized fund structures can enhance investment performance and efficiency, while misaligned structures may dilute investment returns, create misaligned incentives, incur additional fees, and reduce capital deployment efficiency.

 

Long-Term Trends Require Long-Term Capital

In this new era of infrastructure, where digitalisation and decarbonisation dominate the agenda, an increasing number of assets require long-term capital to pursue their growth. Consider a smart metering business with ambitious plans to roll out across an entire region or even country, fuelled by new green legislation. Or a data centre platform riding the wave of AI and cloud computing. But what happens after four years when the investment period is over? The major regulatory and demand trends driving these businesses are unlikely to disappear anytime soon.

This highlights a critical misalignment: general partners and their choice of structure do not always align with the long-term nature of the investments they pursue. The tension between the enduring nature of infrastructure assets and the short-term pressures imposed by closed-ended fund structures has prompted the rise of “continuation vehicles.” However, these structures can give rise to conflicts of interest if not adequately managed. They can also incur significant costs, as running these processes requires a similar amount of preparation and resources as a traditional exit. Additionally, there are unquantifiable costs, such as potential missed commercial opportunities with portfolio companies as senior management are preoccupied with the changes associated with change of ownership.

Funds with an evergreen structure, on the other hand, provide portfolio companies with longer-term stable ownership and access to patient capital. This allows investments to fulfil their growth potential and encourages long-term value creation by aligning the investment horizon with the lifecycle of infrastructure assets. These funds generally have no fees on committed capital, lower performance fee rates, and eliminate the need for continuation vehicles, which often incur additional fees.

Time in the Markets vs. Timing the Market

Open-end funds also offer significant advantages by allowing for quicker capital deployment, continuous exposure, and compounding. This results in higher multiples on invested capital and enhanced performance benefits due to prolonged ‘time in’ the market. To illustrate this point, consider a hypothetical scenario where an evergreen fund delivers an 11% annual return over a 10-year horizon. This continuous exposure and compounding effect associated with open-end funds can result in a higher multiple on invested capital compared to a closed-end fund, which would need to achieve an internal rate of return (IRR) of nearly 20% to match the same multiple given its progressive deployment of capital.

It is a well-known attribute of open-end funds that they provide enhanced liquidity, offering the ability to redeem capital in response to changing investment objectives, flexibility in portfolio balancing alongside closed-ended fund investments, and opportunities for tactical redemptions to realize deferred valuation gains.

However, what is sometimes overlooked, is that for investors not seeking liquidity, these funds offer distribution reinvestment plans (DRIPs), allowing immediate reinvestment of distribution proceeds to further compound returns as demonstrated in the below graph:

Net cashflow and net TVPI for open-end and stylised closed-end fund $100m commitment

Mitigating Risks and Enhancing Transparency

By allowing investors to see where their capital is deployed, open-end vehicles mitigate the risks associated with ‘blind pool’ investments. Such visibility supports additional due diligence, particularly in emerging sectors where certain companies may have less track record.

Platform companies, where non-speculative growth is pursued out of an operational business both organically and inorganically, have enabled mid-market managers to generate strong returns. Open-end funds are particularly well-suited to owning such companies due to their access to permanent capital. From an investor's perspective, these platform companies provide greater certainty of capital deployment into businesses that are already familiar to the investment team.

In addition to reducing blind pool risk, investing through evergreen funds mitigates the risk of the ‘J-curve’ by enabling investors to gain immediate access to an established portfolio of yield-generating asset. Evergreen funds also reduce vintage risk, as they comprise investments acquired over time and through various economic cycles. This diversification across different periods and market conditions helps in smoothing out returns and reducing the impact of any single economic downturn.

Open-end funds typically undergo a rigorous valuation process, with the oversight of external parties ensuring transparency and accountability. Valuations are typically updated quarterly and take into account market comparisons, business updates, as well as inflation and interest rate forecasts.

Investment Strategy Should Dictate Fund Structure

The debate between evergreen and closed-end funds is not a zero-sum game. Both structures play important roles in a diversified investment portfolio, catering to different needs. Ultimately, investment strategy takes precedence, with fund structure being crucial to support execution and maximize value creation. Investors should choose the fund structure that best aligns with the underlying assets and business plans.

In the case of open-end funds, their long-term horizon, lower fees, and continuous capital deployment, enable strategic investment and execution of high-conviction themes over extended periods. While liquidity is a key advantage of open-ended funds, they also offer broader benefits for investors targeting long-duration infrastructure assets, including next generation infrastructure assets with significant long-term capital expenditure needs.