Andrew Sheen asks some of the world's biggest pension funds why they have taken the direct route to infrastructure and whether SWFs are a friend or a foe when it comes to this asset class
The US$240bn California Public Employees' Retirement System (CalPERS) has only recently entered the direct infrastructure investment space, with the decision of the Board last September to adopt an infrastructure pilot programme. Clark McKinley, information officer with CalPERS, explained the rationale for the fund's first foray into direct investment: "[We're] looking for an average annual return on investment from infrastructure of consumer price index (CPI) plus 5% to 7%."
Robbert Coomans, adviser to the Board at APG Investments (the asset management arm of the Netherlands' €217bn ABP fund), summed up the asset class's appeal: "The advantage of direct investments is, apart from the stable cash flows with an inflation component, the fact you don't pay management fees to funds. For a pension fund, these types of investment are interesting." He said the inflation-related aspect could also act as a partial hedge against inflation in the portfolio.
Henrik Gade Jepsen, CIO of beta at Denmark's DKK440bn ATP, added: "What we want is a well diversified portfolio that works well in a large number of economic scenarios - not just when the market is doing well. Infrastructure provides diversification benefits and diversifies our portfolio vis ˆ vis more traditional investments."
McKinley agreed with these sentiments: "Our goal for infrastructure and other components of our new 'inflation-linked asset class' is to give us a hedge against inflation and diversify our portfolio. Infrastructure returns should be fairly stable long term and not as vulnerable to stock market swings as other sectors of investing."
He added that while the CalPERS board wasn't expected to approve the investment policy until mid-August at the earliest, the inflation-linked asset class, which also includes forestry, commodities and inflation-linked bonds, would eventually account for 5% of the entire CalPERS fund (potentially $12bn). Some $3.4bn of assets are already allocated to the sector.
Gade Jepsen said: "As a pension fund, what we're trying to accomplish is to pay our pension benefits in the long run. In that regard we think that infrastructure plays an important part in the overall portfolio." Coomans said the decision to go into infrastructure was motivated by APG's asset liability modelling (ALM) predictions. "We want to have the same risk return characteristics as our ALM," he noted.
Sovereign wealth funds
Sovereign wealth funds (SWFs) have been accused of a lot of things, and 'muscling in' to the infrastructure investment space is no exception. But is this view really justified?
David Denison, president and CEO of the C$122.7bn Canada Pension Plan Investment Board (CPPIB), didn't think so: "SWFs are becoming more active in all kinds of direct investments. So that is something that we're mindful of. In some ways, we will compete with SWFs, but in a number of SWFs we see like-minded investors - they're long term investors. Frankly, that's a very important alignment for us in infrastructure. SWFs can be partners, not competitors."
The fact that SWFs have the capital and expertise to enter the sector highlights that the skill sets and capital required to enter the direct infrastructure investment space are generally accepted to be much higher and more onerous than the listed or fund route.
Vincent de Martel, senior strategist, BGI, agreed with this, saying the barriers to entry were considerable. "With infrastructure, you've got to understand the asset class and how it behaves in different conditions, then you have to educate the trustees of the scheme. After that, you must find out how much you want to invest, then chose between the listed, unlisted and direct routes."
He said the lead time between looking at an investment in the area to allocating money could be as long as two years, clearly a considerable amount of time for any fund.
APG started to invest directly in infrastructure projects a couple of years ago. Coomans said the question of direct versus funds was an important one it had to address: "We started in funds based on the fact that with direct investments you need a much larger and more experienced team. To be in a position to do direct investments, your fund needs a different skill set, and that's where we're at now."
As an example, Coomans said the Ontario Municipal Employees' Retirement System's (OMERS) infrastructure arm had been active in this space for over ten years, with a dedicated staff level of between 30 and 40.
Gade Jepsen agreed that this type of direct investment was more suited to large funds and was probably out of the reach of smaller pension schemes: "I think, to be honest, you'd need to be a very large fund to be able to do direct investments in this space properly. To have the ability to manage these types of assets, a fund needs to build up a large organisation. In terms of the talent, manpower and competencies required, these are not in abundant supply. I don't see it as a situation everyone can enter."
The CPPIB's Denison said: "I think it's true that these investments have to be seen on a case by case basis. Especially [given that] the financing markets are still not anywhere near normal or robust. Individual transactions are more complicated to put together, the bank financing is the hardest. There's lots of equity capital waiting to be deployed, but getting financing for any large transactions is proving to be quite a challenge."
Entry route for smaller funds?
Some have suggested that smaller funds could pool resources and work together as a consortium to invest in large infrastructure projects directly.
Nonetheless, while Gade Jepsen admitted it could be possible for smaller funds to enter the asset class in this way, he said he hadn't seen any specific examples of it, because of the demands of such an arrangment, since all investors need to be aligned on a whole range of issues, such as purpose and investment horizon. Coomans on the other hand was unequivocal about the unsuitability of this approach. "I don't think it's such a viable option for small funds going direct.
The smaller the fund is, the more difficult it is - it would require several people working for weeks or possibly months to put in all the due diligence work, and if you're a small fund you can't afford that." He continued: "I don't think that for small funds the direct route is really feasible. But they can access the asset class through unlisted investment funds with a small allocation."
Gade Jepsen explained that as governments around the world came under increasing budgetary pressures, the logical solution would be to privatise assets, removing them from balance sheets, which would see the scope for direct investments grow: "In the long term, the supply of these assets should be large. If you look at the potential size of the market, it could be as large as the real estate or global equity markets."
Two recent high profile cases involving Canadian pension funds have highlighted the difficulties of successfully completing an acquisition in the direct infrastructure space. The CPPIB's bid for a 40% stake of New Zealand's Auckland Airport and the Ontario Teachers' Pension Plan-led consortium buyout of telco Bell Canada Enterprises (BCE) were both rebuffed.
The Auckland bid was first mooted in June 2007, with the CPPIB in competition with sovereign wealth fund (SWF) Dubai Aerospace Enterprise (DAE). Various factors, including debt ratings and perceived inexperience caused the board of Auckland Airport to reject the initial offers, but in late February 2008 the board recommended shareholders support the bid.
In March, the bid gained the support of the airport's board and over 60% of shareholders, but was rejected in April by the government, as it was judged to be contrary to the Overseas Investment Act.
David Denison, president and CEO, CPPIB, gave Global Pensions his view of the events: "[The Auckland Airport deal] did not meet approval at the political level. The two cabinet members who were the last leg of the bid decided not approve it. From our vantage point, that was fundamentally a political decision, for local, New Zealand political reasons. We'd put that as an isolated incident."
The BCE bid started with the OTPP-led consortium opening take-over discussions in April 2007 and reaching a 'definitive' agreement in July last year for over CAN$50bn. In September, 97% of BCE shareholders voted in favour of the deal, before being blocked by a legal bid by company bondholders unhappy with the terms of the financing. After a lengthy legal battle, the Canadian High Court approved the deal in late June.
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