Agefi Luxembourg - novembre 2024

AGEFI Luxembourg 32 Novembre 2024 Fonds d’investissement By Pascal HERNALSTEEN, Strategic consultant, GoJuSan I magine someone askingme to choose your next book. My rec- ommendationwill likely reflect my preferences more than yours, giv- ing you insight intome rather than the book itself. If you dislike the book, the consequences areminor— you could return it or deal with the small cost. Now,imaginethecostisn’tjust a few euros, but 300,000 € per year, indexed for inflation over a decade, with an additional 50,000 € if you decide to switch. Suddenly, the stakes are much higher. This leads us to the key question: whydowe outsource? For Investment Managers (IMs), outsourcing should bringpeace ofmind, allowing focus on core activities suchasfundraising,marketing,andinvestmentman- agement. However, while comparing service providers’feesisrelativelystraightforward,assessing the quality of service is farmore complex. Cheaperdoesn’talwaysmeanbetter,andthemostex- pensive options aren’t necessarily the right fit either. Quality, in this case, is subjective—it should bemea- suredbyhowwellaprovidercanmeetspecificneeds. DefiningClear Expectations Frustrationoften stems fromthe gapbetween expec- tation and reality. To avoid this, it’s critical to define expectations clearly when it comes to services, tech- nology, human resources, andoperationalmodels. Key factors to consider include: - Shouldyouopt for a“one-stopshop”or se- lect specialized providers for different functions? - Do you require advanced banking ser- vices (e.g., lending, financing)? - How long does investor onboarding typ- ically take? - What is the provider’s employee reten- tion rate? - How much do they invest in employee training? - Are long-term incentive plans available to key staff? -Whatprocessesareoffshored, outsourced, or subcontracted, and how are they coordi- nated? -Howiscybersecurityhandled? -Whatstrategicinvestmentsare being made in operational effi- ciency? CommonPitfalls inOutsourcing WhendissatisfactionarisesbetweenIMsandtheirser- vice providers, it’s often due to issues with accuracy and timeliness. Late reports are irritating; late and in- correct reports are unacceptable. Worse yet, many managers report difficulty reaching the right person when things gowrong, leading to concerns about re- sponsiveness and accountability. Even minor oversights can lead to significant conse- quences, such as: - Missing payment cut-off times related to critical deals, - Failing to send invitations for key investment com- mitteemeetings, - Sending urgent requests to US-based teams on a major holiday such as July 4th. Such errors can damage a management company’s reputation and affect Limited Partners (LPs) nega- tively.AccordingtoPreqin,23%ofIMschangedtheir FundAdministrator(FA)in2019,citingthesereasons: - 56%due todissatisfactionwith service quality, - 33%due to cost concerns, - 11%influencedbyLP feedback about the provider. TheCost ofGetting ItWrong As the saying goes, “If you don’t have time to do it right, whenwill you have time to do it over?” Select- ing the right outsourcing partner is time-consuming and expensive. The due diligence process involves: -Drafting a comprehensiveDueDiligenceQuestion- naire (DDQ), - Compiling a long list of potential providers, - Performing Request for Information (RFI) assess- ments, -ShortlistingprovidersandevaluatingtheirRequests for Proposal (RFP), - Comparing fee proposals, -Negotiating contracts. Choosing the wrong partner results in much greater costs. IMs will need to pay for migration, bear the expense of parallel operations with both providers, and potentially face lost funds and rep- utational damage. Pricing, Total Cost, andValue While everyone aims to get the best price, it’s also es- sential that the fee structure supports sustainable, high-quality service. The total cost of ownership shouldbetakenintoaccount.Considertwoproposals for a 300million € fund: - Provider 1 charges 300,000 €, - Provider 2 charges 330,000 €, which is 10%higher. Over a 10-year period, Provider 2’s additional cost wouldbe300,000€.However,thisdifferenceamounts to just 1 basis point (0.01%) on a 300 million € fund. For a gross performance of 10%, the net performance difference would be negligible: 9.89% instead of 9.90%. In contrast, IMs sometimes need to hire addi- tional accountants to verify and correct their FA’s re- ports, adding hidden costs that further reduce the value of the service. OutsourcingModels: One SizeDoesn’t FitAll InEurope, outsourcing is common, butmanyAmer- ican IMs prefer to manage their funds internally (in- sourcing).SomeIMsseekamiddleground,optingfor a“co-sourcing”model,wheretheFAworksremotely on the IM’s systems. This allows the IM to maintain full control over data and risk while reducing migration and switching costs. Though it’s not easily applicable in Europe due to regulatory constraints like data protection, co-sourcing offers greater control and transparency, with fewer risks of service disrup- tions or hidden costs. Conclusion Selecting the right FA is a significant investment in time and resources. While it’s tempting to focus on price, a poor-quality provider can lead to far greater costs,impactingnotonlythefundbutalsoitsLPsand stakeholders. Switching providers involves time, energy, and ex- pense, so getting the decision right from the start is crucial. Consider appointing a local independent Non-Exec- utiveDirector(NED)tooverseetheFA’sperformance. Ultimately, the right provider will meet your needs andmaintainhighstandards,contributingtothelong- termsuccessandreputationofyourinvestmentman- agement firm. Thiseffortshouldbeseenasaninvestmentratherthan a sunk cost. Selecting the Right Outsourcing Partner for Investment Managers I n the context of the EuropeanUnion’s ambitious climate objectives, Infra- structure is undoubtedly the asset class that is expected to capturemost of the fundraising for the energy transi- tion.While such expectationwill lead to important opportunities for an assets class having proved strong resilience in previous years, it will also consti- tute an important challenge for the sector as investors and stakeholders’ scrutiny on the non-financial objec- tives for Infrastructure funds, drivenby institu- tional investors, is gaining in importance. To reach carbon neutrality and become the first carbon-neutral continent, the European Union (EU) in its Green Deal, agreed to unprece- dented targets to decarbonize its energy system which accounts for more than 75% of EU’s green- house gas emissions, including a reduction of its emissions by 55% by 2030 bringing them at the level of 1990. This objective relies on several impor- tant goals such as increasing renewable energy ca- pacity and enhancing energy efficiency for which sustainable infrastructure funds are expected to play a pivotal role. However, sustainable strategies are gaining popu- larity across all alternative asset classes, including infrastructure. Limited partners and more specifi- cally institutional investors becomemuchmore de- manding and go well beyond the disclosures foreseen in the Sustainable FinanceDisclosureReg- ulation (SFRD) for Article 8 and Article 9 funds when analyzing the expected non-financial return of their investment. This additional layer of ESG re- porting increases the requirement for voluntary as- surance, often seen as the best option to get an independent level of comfort on the sustainable na- ture of an infrastructure fund. This article offers an overview on the impact of the European Green Deal on infrastructure funds and highlights the evolution of the Europeanmarket as compared to North America. It also discusses the significance of sustainability analysis and reporting for investors resulting ingreater demand for volun- tary assurance. Greater and greener European focus delivering strong returns Thedifficult global fundraising environment affect- ing all private asset classes naturally also impacted infrastructure funds. The Investment data company Preqin Ltd estimated a total amount raised of EUR 20 billion as of October 2023, only 12% of the 2022 recordyear’s amount of EUR168 billionand15%of the five-year annual average of EUR 130 billion. At the same time the European infrastructure mar- ket has grown considerably, powered by EU’s cli- mate goals and green transition efforts. This trend is supported by the number of infrastructure funds targeting Europe which, still according to Preqin, has grown by 59% over the previous year and by totalAssetsUnderManagement (AUM) forEurope- focused funds which maintained their upward trend to reach37%of globalAUMas ofMarch2023, just 6% lower thanNorthAmerica-focused funds. Inaddition to this greater European focus, the infra- structuremarket alsowitnessed important changes, driven by the European Green Deal’s ambitious goal of carbonneutralityby2050whichsignificantly impacted themarket: - Rising Renewable Energy Investments : Euro- pean infrastructure funds are increasingly targeting renewable energyand important investments inoff- shorewindparks, solar energyprojects, andhydro- gen technology align with European goals for decarbonization and energy security. - Expansion of Digital Infrastructure : As digitali- zationdrives economicdevelopment, Europeanhas rapidly expanded data centers, 5G networks, and fiber optics. The European Commission’s push to enhance digital capacity has further propelled this growth, meeting increasing demand for data and connectivity. - Advancements in Sustainable Transportation : Investments in transportation infrastructure, such as electric vehicles, charging stations, rail systems, and urban mobility solutions, have grown in re- sponse to European policies focused on reducing emissions in transporta- tion, a key contributor to Europe’s carbon footprint. In terms of performance, Europe’ strategicemphasisonsustainablein- frastructure combined with the strength of its energy markets and elevated power prices, boosted the return of funds with exposure to energy and infra- structure assets. Pre- qin’s analysis of Internal Rates of Re- turn (IRR) from2019 to 2022 highlights a significant perform- ance gap between Eu- ropean infrastructure funds, which achieved a me- dian IRR of 14.1%, and North American infrastruc- ture funds, which had amedian IRRof 8.6%. European infrastructure funds not only delivered higher IRRs but alsoprovided competitive risk-ad- justed returns, especially in core and core+ strate- gies. These lower-risk approaches have gained traction as they appeal to investors seeking stability in a volatile economic environment. In contrast, North American funds faced greater exposure to fluctuating public market conditions, which im- pacted overall returns. Sustainability as a key investor requirement Formany institutional investors the analysis of non- financial performance at appraisal has become an essential component of their Due Diligence which shifted from a “nice-to-have” to a “must-have” fol- lowing EU’ Sustainable FinanceAction Plan signed in 2018 and the two implementation waves of the SFDR onMarch 2021 and January 2023. Gabriele Todesca, Head of Infrastructure Invest- ments at theEuropean Investment Fund (EIF), EU’s largest Limited Partner (with over EUR 1 billion of commitment to EU infrastructure funds in 2023) confirms this trend “Sustainability is at the core of our investment activity, particularlywhenwe invest in infra- structure funds. This is true for thewholemarket, but par- ticularly for a policy-driven investor like the EIF. Most of the resources managed by the EIF are from public-sector investors, who have a strong focus on policy objectives in- cluding decarbonization and the green transition. They are also very sensitive to potential “greenwashing” prac- tices in the industry. For these reasons, whenmaking in- vestments in funds, the EIF focuses a large part of its due diligence work on the sustainability-related aspects of the projects. For this, the EIF benefits from the support of an in-house technical department that assesses the strategy, the target sectors and the approach to the target sector, to ensure that investments are carried out in a sustain- able way. Sometimes we have to exclude certain invest- ments from fund’s strategies or request that if done, they’re done in a way that complies with sustainable practices that we define.’’ With an increasing demand and opportunities for European sustainable infrastructure combined with a bigger scrutiny on the sustainability com- ponents of their investments, SFDR disclosures and especially for Article 8 funds, are not always enough to provide investors with the required level of comfort on the impact their investments. Therefore, more andmore infrastructure funds are issuing various types of sustainability reports, such as GreenhouseGas Emissions Report, Sustainabil- ity Report or Carbon Footprint Reports, the to the attention of their stakeholders. What does the future hold? Looking forward we identify two significant trends which will impact the infrastructure fund market in the coming years. First, we believe that the growth trajectory of EU- focused infrastructure funds is expected to con- tinue, driven by EU’s climate targets and energy transition efforts, which call for an increase in re- newable energy capacity and enhancements in en- ergy efficiency. This could lead to European’s AUM to surpass North American-focused funds and become the first market for infrastructure funds but also the most appealing one thanks to strong and stable return. This could expand the in- vestor base of the segment beyond institutions by attracting more private investors and high-net- worth individuals. Last, in this rapidly evolving environmentmarked by stakeholders in demand for reliable and robust sustainability information, voluntary assurance in the form of limited or reasonable assurance re- ports, will emerge as a crucial mechanism for en- hancing the credibility and transparency of non-financial reporting. Independent third-party verification, ensuring that the reporteddata are ac- curate and reflective of the funds’ true impact on sustainability, will certainly have a positive impact on fundraising, reputation and performance thereby fueling a virtuous circle. Raphaël BETTI EY LuxembourgAssurance Partner, Climate Change and Sustainability Services Leader ZeeshanAHMED EY Luxembourg Partner, Infrastructure Leader Sustainable Infrastructure as the backbone of the European Green Deal