How Australian instos play the infrastructure game

Cerulli Global Edge, October 2011

Infrastructure is often painted as a perfect fit for pension and sovereign wealth funds. It gives off regular and steady income over the long-term; its income stream behaves in a predictable manner, matching pension fund liabilities; and it suits an investor in no rush to get money out again.

In Asia Pacific, it has another advantage too: an inflation hedge. Most of the world has far more pressing things to worry about than inflation – chance would be a fine thing – but many Asian nations are battling strong inflationary pressures, notably China, Indonesia and (to an alarming degree) Vietnam. Infrastructure, again because of its long-term and defensive nature, but also because of its lack of correlation with other asset classes or commodities, makes for a useful hedge.

Australia, with one of the biggest and most sophisticated pension fund environments in the world, has been a forerunner in this process, particularly through the not-for-profit industry superannuation funds.

One asset consultant in particular, called Access Economic Advisers, has built a name for itself putting clients into infrastructure assets. As recently as August, it bought a 20.8% stake in International Parking Group, which owns nine hospital car parks across New South Wales and Queensland, on behalf of Prime Super. Other assets AEA has bought into on behalf of pension fund clients include Adelaide Airport, Flinders Ports, GasValpo (a Chilean gas distribution company), and Texas Tollroad.

A super fund advised by Access typically has two portfolios: a market-linked portfolio, made of mainstream assets in debt and equity, and a target return portfolio, which is made up of alternative asset classes. This target return portfolio can make up as much as half of total assets. Investors in the MTAA super fund, for example, share in the fund’s A$1.371 billion of directly managed holdings in infrastructure including Southern Water and Thames Water in the UK, the airports of Brisbane, Sydney and Adelaide, and ports in Adelaide and Gdansk, Poland, among other things. That’s on top of holdings in infrastructure funds from groups like Macquarie, and another fund that specializes in Latin American power. Westscheme, recently merged with Australian Super, is another example of an Access superannuation fund client that has built separate portfolios in this way. Another, Victoria Funds Management Corporation, has a direct holding in Birmingham Airport in the UK.

The king of infrastructure investment and funding in Australia has long been the Macquarie group, which over the years has built numerous listed and unlisted infrastructure funds. Several super funds get their exposure to infrastructure through holdings in Macquarie vehicles. But this also raises a cautionary tale: infrastructure doesn’t necessarily perform well as a stock market vehicle. An example is Macquarie International Infrastructure Fund, an Asia-focused listed infrastructure fund which floated at S$1 per share in Singapore in 2005. Six years on, it’s trading at about half its listing price, having been mauled by the financial crisis and never recovered. Its assets – stakes in Changshu Xinghua Port, Hua Nan Expressway, Miaoli Wind and Taiwan Broadband Communications – all have good prospects, and the underlying premise of the fund is very sound: Macquarie, citing the Asian Development Bank, says that infrastructure investment needs in Asia are estimated at US$8 trillion over the next 10 years. Very clearly, there is money to be made in that process. But a combination of market suspicion about debt loads, and of listed vehicles generally, mean that investors in the stock have wasted six years of patience to lose half their money. It could be worse: Babcock & Brown, the Australian institution built on a Macquarie-like model of infrastructure development, folded in the financial crisis, although its listed fund lives on.

Investors have become wary of vehicles like this because of their lack of liquidity. It is often whispered in Australia that some industry funds dodged a bullet in the financial crisis in this respect. Industry funds had, for several years, posted better returns than their commercial peers, partly because they had a higher level of holding in unlisted assets, which raised the thorny question about how such illiquid assets could be valued accurately. As the financial crisis kicked in, the value of those assets unquestionably declined  – but to what? At that stage, had a fund needed to sell infrastructure, it probably couldn’t have done so at any price, since there is no liquid market and there were no obvious buyers in a period of panic. If one of the infrastructure-heavy industry funds had faced a lot of redemptions and needed to sell assets, it might have struggled to do so. One of the reasons this never happened is because Australian superannuation is governed by strict laws on when people can access their retirement savings; most Australians had no option to redeem funds, hence no big redemptions as markets started to fall. But the questions about the prudence of having up to half the fund in unlisted assets are valid, and continue to be asked.

But for institutions that really don’t need liquidity, infrastructure is still a good fit, and clearly the part of the market best suited to this approach is sovereign wealth funds. Here, too, Australia is an early mover. As of June 30 2011, the Future Fund – the closest thing Australia has to a sovereign fund, tasked to meet future pension liabilities – had A$3.911 billion in infrastructure and timber investments, accounting for 5.3% of the fund; the long term target allocation is for 20% to be invested into ‘tangible assets’ (which is infrastructure, timber and property). Specific examples include Southern Water in the UK and the owner of Melbourne and Launceston airports. This has proved promising for external managers – the Future Fund discloses seven managers in infrastructure and timber – and the Future Fund has also made several internal hires of people brought in for their infrastructure expertise.

Elsewhere in the region, too, infrastructure is growing in popularity as an asset class. China Investment Corporation moved to a 21% allocation to alternatives in 2010, with specific areas of focus in REITs, infrastructure and private equity. CIC is an example of a sovereign fund very clearly attempting to hedge against inflation, and not just with infrastructure: new strategies it added in 2010 included a metals and mining indices swap, a gold equity fund, an active commodity index strategy, and various futures also apparently geared towards inflation targeting. CIC now has a dedicated department for special investments, which covers energy, mining, precious metals, agriculture and infrastructure.

The Government of Singapore Investment Corporation doesn’t separate out infrastructure, but has a figure combining it with private equity and venture capital. In 2010 that figure was 10% of the whole portfolio; and Indonesia has been a recent target for its infrastructure investment. Also in Singapore, Temasek, the other sovereign fund, made a S$100 million investment in Hutchison Port Holdings earlier this year. And the Korea Investment Corporation is targeting 20% of the portfolio in alternatives generally, including infrastructure.  (It’s also been boosting inflation-linked bonds.)

Groups like these, perfectly geared towards infrastructure’s characteristics, are likely to do more and more of this kind of investment in future; it’s a happy coincidence of interests with Asia itself, which needs a huge amount of infrastructure development and will clearly need more funding than governments can directly provide in order to do it. At this end of the investment spectrum, there’s a great deal to recommend the asset class – but those who seek to package it into listed trusts to be sold to retail have more work to do before they can regain public trust.