Monday, March 5, 2012

Infrastructure Comes of Age?

Dan Milmo of the Guardian reports, Pension funds back George Osborne's infrastructure plan with £4bn:

British pension funds aim to launch a multibillion-pound infrastructure fund next year that will invest up to £4bn in government projects from roads and high-speed rail lines to power stations.

The Pension Protection Fund and the National Association of Pension Funds are in discussions with 20 others to create a vehicle that will consider investing in the projects outlined by the chancellor, George Osborne, in last year's national infrastructure plan. That shortlist will be whittled down to between 10 and 12 contributors, who are expected to put in starter capital – to fund staff hires – and a further cash injection to launch the investment fund. The NAPF and PPF are aiming to raise between £1bn and £2bn in an initial fundraising drive that could rise to between £3bn and £4bn with leverage, as they target a launch date of January 2013.

Alan Rubenstein, chief executive of the PPF, said: "Our focus is building a core of something like 10 to 12 funds who will put up development capital to take us forward to formal launch in January 2013. We are making good progress."

Rubenstein expects the founder funds to contribute about £1bn, with a further £1bn raised by subscriptions from other investors.

The fund could follow the example of Australia's Industry Funds Management, an investment vehicle whose infrastructure interests, which include Anglian Water in the UK, are worth A$10bn (£6.8bn). The PPF envisages that the fund will be a not-for-profit entity, with any surplus reinvested in further projects, although initial earnings will be used to pay off the startup capital and loans. "One thing pension funds have told us is they don't like unnecessarily costly fee structures, so we are looking to set the platform up as a not-for-profit vehicle," said Rubenstein.

Another model the fund could follow is Borealis in Canada, which takes a significant stake in deals and is co-owner of a 30-year concession to operate the High Speed One rail line between London and the Channel Tunnel.

It is understood that the NAPF and PPF have not ruled out sharing management of the fund with a leading infrastructure investor. The PPF's bullishness is in contrast to scepticism over whether the government will be able to secure the £20bn in investment it is seeking from pension funds and the insurance community. KPMG warned last week that British funds do not have the skill set to invest in infrastructure, while new solvency regulations for insurers could impede putting such projects on their balance sheets.

The infrastructure fund is the product of a memorandum of understanding signed by the NAPF and PPF with the government last November, in which the groups pledged to develop an investment vehicle for big projects.

According to the national infrastructure plan published in Osborne's autumn statement last year, the government needs £200bn of investment in transport, power and telecoms projects over the next five years and the majority of the funding will come from the private sector.

The PPF has about £10bn under management and was launched in 2005 to run the pension assets and liabilities of companies that have folded with underfunded defined-benefit schemes, covering about 12 million members. The NAPF represents 1,200 pension funds who hold assets worth £800bn.

Investors are believed to be mulling some outstanding issues with the fund, such as insuring against the construction risk inherent in new-build or "greenfield" projects, from high-speed rail lines to power stations. Investors are traditionally nervous of underwriting construction projects that could, for a variety of reasons, run over budget or suffer from serious technical problems once launched.

Investors are discussing whether the government can provide a guarantee for construction risk or whether state-controlled banks could get involved, possibly through issuing convertible bonds that transform into equity upon completion of the project.

Everywhere you look, infrastructure is a hot topic. Governments are looking to boost investments to create jobs and they are opting for public-private partnerships to realize these mammoth investments.

Pension funds are also increasing their allocations to infrastructure. Sam Riley of Top 1000 Funds reports, Infrastructure comes of age in low returns environment:

As cash-strapped governments around the world come under pressure to sell public assets, capital-intensive investors are searching for stable yielding investments, bringing the maturing infrastructure asset class back into the framework. Sam Riley looks at examples from around the world.

The infrastructure asset class has come full circle from its frothy pre-crisis days where some managers were spruiking the promise of private equity like returns on the back of high gearing and more risk.

Investors in North America, Europe and Australia share a renewed focus on the stable, yielding characteristics of infrastructure.

AustralianSuper is a 14-year veteran of the infrastructure asset class. The fund’s head of infrastructure Jason Peasley says that the conversation between institutional investors and their managers is again concentrating on long-term objectives.

“There are more conversations about long-term performance and a more conservative risk/return spectrum, particularly by institutions like AustralianSuper,” he says.

“Excess leverage is definitely a dirty word, disintermediation is also another aspect that people seem to be talking about in terms of going direct and having more co-investment, and avoiding the pooled-fund model. We don’t necessarily subscribe to that, as historically we have utilised managers and pooled vehicles, but definitely these are the types of conversations going on right now.”

The renewed focus on the stable, yielding characteristics of infrastructure is shared by investors on both sides of the Atlantic.

Universities Superannuation Scheme’s senior manager of alternatives Gavin Merchant says the aim of its infrastructure program is to invest in long-term, inflation-linked assets which provide cashflow that match the scheme’s long-term liabilities.

Infrastructure represents about a fifth of the fund’s £5-billion ($7.8 billion) allocation to alternatives, while its alternative assets represent about 16 per cent of the total $55 billion portfolio.

Merchant says the fund plans to increase its commitment to infrastructure in the coming years, eventually taking its allocation to between 5 and 7 per cent of the overall portfolio.

The push to increase exposure to infrastructure is shared by CalSTRS which, like USS, is looking at stable, regulated assets that provide an inflation hedge and will match its long-term liabilities.

CalSTRS head of infrastructure Diloshini Seneviratne says the fund’s investment team took more than two years looking at opportunities globally before the $110-billion fund dipped its toe in last year.

The first mandate it awarded was to First Reserve’s debut fund, which has a renewable energy focus and Seneviratne says that it is looking to increase its allocation over time to $3.5 billion or 2.5 per cent of CalSTRS’ portfolio.

Infrastructure will eventually make up half of CalSTRS inflation sensitive-asset bucket, which also includes global index-linked bonds and Treasury Inflation Protected Securities.

Industry Funds Management (IFM) recently landed an up to $500-million mandate from CalSTRS to invest in global infrastructure.

IFM chief executive Brett Himbury says institutional investors are looking to increase their exposure to infrastructure, with core, mature assets in developed markets in particular demand.

IMF manages more than $10 billion in infrastructure investments in an open-ended fund.

Himbury says that while there is an increasing amount of capital flowing into the sector, there is a shortage of deals, with a growing amount of money chasing quality assets.

“We are seeing our clients increasing their allocations to infrastructure and we are seeing that globally,” he says.

“So, while we are seeing an increase in the deal supply, we are also seeing an increase in the capital available. I would still say we have more capital than we have deals; there is a lot of appetite out there,” Himbury says.

Growing market

An OECD working paper looking at the investment in the asset class by pension funds estimated that the global market size spanned somewhere between $10 trillion and $20 trillion.

Alternative-assets researcher Preqin puts the number of infrastructure investors at 1352 globally and says the mean current allocation to the asset class is 4 per cent.

In its 2011 Infrastructure Fundraising and Deals report released in January, Preqin found that funds are typically looking to increase their allocations, with a mean target allocation of 5.3 per cent.

Himbury says that with more global investors looking to increase their infrastructure exposures, particularly to these high quality developed-market assets, there is a risk that prices will be pushed higher.

“In many parts of the world the risk-free rates are very low and you combine that with a high level of capital flowing towards infrastructure assets and there is clearly a risk that prices may be bid up,” he says.

“We think that we are seeing an increase in the demand for open-ended funds because in an environment where prices may be bid up, you don’t want to have the pressure to deploy the capital in a short amount of time if you are running a closed-end fund.”

The Preqin report found that more than a third of infrastructure investors were public or private pension funds, with the majority located in the US, UK, Australia and Canada.

It also found that investors still overwhelmingly prefer unlisted funds, with 81 per cent of investors surveyed expressing a preference to invest in unlisted funds, followed by 31 per cent who say they favoured direct investing.

Direct Investing

For AustralianSuper, this preference for pooled investments may be starting to change, according to Peasley.

The fund has been able to alleviate some of the drawbacks of open-ended funds – in particular where different investors in a fund have contrasting objectives and time horizons – through the ownership structure of IFM.

IFM is owned by AustralianSuper and 31 other industry superannuation funds, encouraging a closer alignment of interest between owners and management, as well as ensuring that investors are all long-term in their outlook.

Peasley says that the fund has a target allocation of 11 per cent of the total fund for infrastructure and is looking to double this in five years as the total size of the fund is also projected to double over this time period.

To increase its exposure to infrastructure AustralianSuper will need to move beyond pooled funds and invest directly, particularly in Australia, where it is looking to increase its exposure to core infrastructure.

Long-term investors such as Dutch asset manager APG – which manages the investments of the $329 billion Dutch pension fund ABP – have also increasingly moved to club or co-investments in the last couple of years in an effort to avoid hefty management fees.

Being closer to its investments, as well as investing with like-minded investors has also allowed APG to look at defining standards for its infrastructure investments that include looking at improved environmental, social and governance factors and long-term performance benchmarks.

Moving away from a fund approach has also given APG more direct control over the correlations of its infrastructure holdings.

In the past the asset manager has found that assets like toll roads have seen as much as a 30 per cent drop in traffic because a decline in economic conditions led to less commercial traffic flows.

The direct move is one that USS is also looking to make, with the fund saying that it wants to get closer to its infrastructure investments, which have typically been in core utilities and transport assets.

“Going forward, we are employing a direct investment approach rather than investing through infrastructure funds,” Merchant says.

“We are a financial investor that takes its responsibilities very seriously, which generally includes a requirement for board representation. Our preferred approach is to work with like-minded investors (be they pension funds, infrastructure funds or strategics) who are aligned with us in how they think about the asset.”

Seneviratne says that direct investing is a long-term aspiration for CalSTRS, but that the fund is first looking to learn from established managers like IFM before taking that leap.

Return Targets and fees

CalSTRS has a benchmark of the consumer price index plus 5 per cent for its infrastructure investments.

AustralianSuper aims for equity-like returns with lower liability and less volatility.

IFM reports that since its inception it has achieved a 12.5 per cent return net of tax and fees.

Himbury says that pooled management does not necessarily have to lead to funds paying high fees.

IFM’s fees are 45 basis points but the OECD report into infrastructure funds has found fees were similar to private equity without necessarily achieving the same performance.

The OECD found that cost to the investor was typically a base management fee of 1 to 2 per cent and a performance fee of 10 to 20 per cent, usually with a hurdle rate of 8 to 12 per cent.

But funds that are looking to directly invest need to weigh fees paid to a manager up against the cost of building and maintaining in-house expertise, the ongoing cost of managing an infrastructure asset over the long-term, and the fees and costs associated with the transaction itself.

While investors can mitigate these costs to a degree through co-investments, Himbury says that much of the alpha of an infrastructure investment is achieved through the ongoing management of an asset, which takes considerable capacity and experience.

Preqin also finds that the fees fund managers can demand has come under pressure particularly in light of the difficult fund raising environment faced in the last couple of years.

In 2011, the number of deals made by unlisted funds fell to its lowest level since the financial crisis, declining by 49 per cent to $31.8 billion, Preqin found.

“The balance of power between investors and fund managers when negotiating terms and conditions has shifted towards the investors somewhat in recent years,” the report’s author Iain Jones finds.

“This means fund managers will have to ensure that their terms, especially those relating to management fees and carry structure, satisfying investors if they are to be successful in this increasingly competitive fundraising market.”

Crisis and opportunity

While there is increasing capital looking to find infrastructure assets, the after-shocks of the global financial crisis are also leading to the potential for more assets to come on stream.

With both sovereigns and financial institutions looking to shed debt and sell assets, long-term investors are looking at what prime assets may be coming up for sale in both Europe and America.

Ireland is an early example of where sovereign wealth funds and private investors may co-ordinate to buy core assets.

The Irish government through its bailout deal with the International Monetary Fund and the European Union has committed to selling off $2.64 billion in assets over the next two years.

Ireland’s sovereign wealth fund, the National Pensions Reserve Fund (NPRF), has been tasked with providing seed capital for a group of funds looking to invest in infrastructure, venture capital and credit for small to medium businesses.

Eugene O’Callaghan, the director of NPRF, says that the fund has already committed $330.8 million to an infrastructure fund and has sought interest from investors in Asia and Australia to eventually reach a total of $1.32 billion.

He denies that the NPRF could ultimately be involved in a fire sale of government assets, saying that the government is, unlike other governments around the world, just starting down the path of privatisation.

“We are operating on the basis that there definitely won’t be a fire sale but there is a committed seller so the assets are likely to be available at reasonable prices,” he says.

Ireland is not the only cash-strapped government looking to the private sector to invest.

Britain’s Chancellor of the Exchequer George Osborne has recently called for British pension funds to invest more money in domestic infrastructure projects.

The conservative government has flagged an overhaul of the investment framework to encourage investors and has called for the industry’s views on what incentives are necessary.

In the US there are bills that have been introduced in both the Congress and the Senate for an infrastructure bank that would be funded with up to $30 billion.

The bank would look to partner with private investors to build nationally significant projects and sell long-term bonds of up to 50 years to support the institution’s ongoing operations.

But while governments are looking to incentivise investors, Himbury says that the real problem is not “sweetening” the deal, but the number of deals.

He notes that the old private equity-type investment model soured the politics around public-private partnerships, with unrealistic returns objectives breeding public suspicion.

“Our view is not about making the deals sweeter but making the deals available, and we would like to see more available deals around the globe not necessarily incentivising through tax or other structures,” he says.

“We are not short of capital, we are not short of expertise or interest in the sector, notwithstanding a bit of a flurry of activity recently, we are short of deals globally.”

Mr. Himbury is absolutely right, the problem isn't lack of capital, the problem is lack of expertise and lack of deals globally.

A friend of mine who is an expert in infrastructure tells me that many pension funds overestimate the risks of greenfield projects and underestimate the risks of managing infrastructure investments once they enter a deal. "These assets are long-term assets and require a specialized expertise. A lot can happen over 20 and 30 years. Too many pension funds hire investment banking types, which is fine, but they do not have guys and gals with actual hands on operational experience in infrastructure."

One thing is for sure, as more money flows into infrastructure, the deals will get priced up. Having said this, there are deals and plenty of opportunities. This morning I read that the Greek government appointed Guggenheim Partners LLC to act as financial adviser on the 20 billion euro ($26 billion) Helios solar project it’s considering to help boost income from renewable energy. Deputy Energy Minister Yiannis Maniatis said today in an interview on state-run NET TV that Greece could cover 30 percent of its energy needs from its own resources.

Greece expects bondholders to accept a one-time offer to write off about 100 billion euros ($140 billion) of Greek debt and is ready to force them to participate if necessary. “This is the best offer,” Venizelos said in a Bloomberg Television interview with Nicole Itano in Athens today. “This is the best offer because this is the only one, the only existing offer.”

Finally, Plamen Monovski, president and chief investment officer of Renaissance Asset Managers, discusses the prospects for Russia's economy following Vladimir Putin's re-election as president. He talks with Maryam Nemazee on Bloomberg Television's "The Pulse." Mr. Monovski sees tremendous opportunities in Russian infrastructure as the government looks to privatize state assets.

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