Debate: Infrastructure – a new asset class?
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Debate: Infrastructure – a new asset class?

The advent of whole-business securitization and the creation of a liquid market in project-related debt has opened investors’ eyes to the rewards available in infrastructure. Governments’ desire for off-balance-sheet funding has also boosted the supply of suitable investments. But what makes infrastructure different? How do you buy it, sell it and manage it?

Debate participants

AC, State Street How would you define infrastructure? Is it a definable asset class or is it a subset of other asset classes?

RC, ABP Initially, because of the lack of historical data, our research department at ABP had difficulty deciding if infrastructure had different enough risk and return characteristics to call it a separate asset class. But because we didn’t want this to hold us back, we started by investing in infrastructure under the umbrella of what we call strategic real estate, because they share a lot of the same characteristics. Since then we have decided to treat it as a separate asset class in our allocation process, because it does have different characteristics; it has stable cashflows, and it’s less dependent on economic cycles than, for example, real estate.

PW, Henderson There is a tendency to define infrastructure by its characteristics and how the investments perform. We use a simple economic definition – quasi-monopolies, with regulated or government-backed income streams, and relatively low risk – as opposed to the classic definition based on what infrastructure does and the services it provides, for example, roads, ports, airports and other basic facilities to support an economy. I’ve only ever seen two or three efficient frontier analyses done on the performance of infrastructure, so it is difficult to get hard data. It’s also difficult to correlate it with other things. It doesn’t perform like equities and it doesn’t perform like fixed interest, but it does have some characteristics that are similar to some types of fixed-income instruments. And it does have some property-like characteristics as well.

CM, Standard Life We focus on infrastructure project bonds, and define it as covering two broad sectors. The first is the more traditional non-recourse project finance. This is quite often energy, but can be roads and PFI projects. It’s usually a contractually driven single asset but that can also include market risk projects. The second is the infrastructure, like water companies, or the BAA potentially, where it’s more of a proper company, with a defensible, potentially monopoly-like, more stable revenue stream, although there’s more operational risk, more management risk, and strategic risk. These can have similarities to another asset class, whole-business securitizations, such as pub and hospital securitizations. You might not think of pubs as a traditional infrastructure asset, but in many ways the techniques used for doing pub securitizations are also applied to ports, for example.

PW, Henderson You can look at the investment opportunities like that as well, there are two types of infrastructure fund which overlap: those generally investing in non-recourse project finance, private finance initiatives (PFI) and public-private partnerships (PPP); and those investing in much broader infrastructure – airports, ports – assets which have different operational business characteristics. They are certainly different from the debt side but also from the equity and the equity risk point of view as well. At the moment you’re seeing a growth in investor interest coming partly from traditional private equity – where they have a shortage of deals at the right sort of prices – drifting into the more operational business-like area of infrastructure. So it’s a combination of the fact that funds are targeting infrastructure with private equity characteristics and that there’s equity capital available to do it as well.

HM, ABN Amro In our minds, infrastructure equity fits within alternatives slotted between private equity and real estate, reflecting investors’ return expectations in the light of risks taken. I also find the debt element quite interesting, because many projects and assets only have a chance of being financed in the public debt markets either by way of an investment grade rating, or by getting a monoline wrap. Unless you have a public debt rating, you drift into the bank market to raise funding. And in the bank market, project financing is more tightly priced than would be the case with high-yield investments, which otherwise have similar risk characteristics.

AC, State Street Is this creeping definition problematic when you’re talking to investors?

PW, Henderson It depends on who the investors are. The more sophisticated investors are looking for sectors where they believe there’s an arbitrage, a gain, where risk and reward is potentially mispriced to a degree. So for certain types of existing long-term investors, it’s probably been advantageous that infrastructure was not an easy sector to define or analyse ...

HM, ABN Amro ... because it restricted the supply of capital.

PW, Henderson Exactly. And so some investors took advantage of that, just as early entrants into other forms of private equity did. When information becomes more widely held you lose that type of advantage.

CM, Standard Life From a debt perspective it only becomes problematic when people use the term infrastructure as a way of imputing regulatory or revenue stability to assets that in fact aren’t stable. And as it becomes popular with a wider choice of assets under the infrastructure umbrella there is a risk that people might confuse more risky assets with traditional infrastructure.

RC, ABP Because we have a top-down approach in our asset allocation, risk characteristics are very important. We don’t like to allocate money to infrastructure with certain risk characteristics and then find that we have invested in private equity. We are not against private equity, but that’s a different allocation. Funds have to do what they say.

HM, ABN Amro Another way of defining infrastructure is to look at it from the perspective of the investor – they see this asset class as a means to match long-dated liabilities with fairly secure cashflows of corresponding assets with a long life. By that definition, assets where the volatility of cashflows is too high for them to qualify as matching assets for those liabilities don’t amount to infrastructure.

Arbitrage returns

AC, State Street What arbitrage should you be capturing by investing in this asset class?

PW, Henderson In some cases the arbitrage between a liquid and an illiquid market. It’s much easier to make the debt in infrastructure liquid. Even if they’re project financed, you can often rate them, and all of that creates a market and provides liquidity. But liquidity has not traditionally been very high in infrastructure equity. So funds provide a bridge between the two. We think the premium to straight equity is several percent, maybe up to 3%. You capture some of that premium for the investor. You also often capture the change in risk in an asset or in a business over time. At the beginning of a power plant contract, it’s ‘We’ll back this construction company and this counterparty is our credit to pay X in the future.’ That risk is quite different to buying into a power station after it’s been operating for 10 years.

HM, ABN Amro Yes, and even when the project is operational, the equity risk premium should be somewhat higher than the normal equity premium because of the illiquid nature of the investment. The question is how much more can be priced into it to secure the asset; so much depends on other variables such as demand, asset risk, minority interest, etc.

RC, ABP That range of risks means that we can include a range of investments, with different characteristics, within our portfolio. There are investments with 10 years’ proven track record of cashflow that still have 20 years to go, and also projects that are just starting up or under construction.

PW, Henderson And as the risk of a project changes over time, the ability to refinance and bring forward the gain from that movement in risk, is often another driver. With current debt pricing we are at a highly attractive point in the cycle and this has in part driven the recent increase in the attractiveness of infrastructure investment as a sector overall.

Cyclical factors

CM, Standard Life Yes, that is right and we believe that therefore the sector is cyclical. Ten times leverage does give you quite an arbitrage if it goes well. If it goes wrong, it gets rather painful.

HM, ABN Amro Another element of cyclicality is the general interest climate. Current interest rates make it attractive for governments to fund investments through PPP projects. When rates go up, there is a risk that the project funding charge, including the risk premia for debt and equity, will go up substantially, thereby making it less attractive overall. Higher interest rates will also make refinancings more difficult to justify.

AC, State Street Has some of that change in the riskiness of the sector already occurred?

RC, ABP In the secondary PFI market at the moment you have to question whether the returns still on offer are realistic, given the risk.

PW, Henderson If the debt pricing stays where it is, it may not be sustainable, because the only thing that will move is the price of the assets, which will get relatively more expensive. Currently you can buy assets singly between 7% and 12%, depending on what they are, what their risk/return is and how much refinancing potential there is in them. Somewhat bizarrely to outsiders, assets that have more refinancing potential cost more. If you have continual improvement in debt pricing, the price for those assets will fall until you can make a better return by investing in government bonds. Infrastructure is not immune to market pricing issues. Like all markets, there’s a floor set by the alternatives that investors have.

HM, ABN Amro I think that’s true. On the secondary side, the listing of the HSBC fund is interesting because it’s the first time, here in Europe at least, that a fund has listed and provided some liquidity and market pricing. And if you study Australia, there are quite a few discrepancies between how some of the listed funds have developed compared to the indices; some favourably, others less favourably.

RC, ABP The Australian funds fared reasonably, not only against equities, but also against other indices. But in many cases they were able to raise capital whenever there was a new opportunity in the market. That helps the older investors, because with each new issue there are more favourable terms, or they would never raise the money. So that has helped their performance record, but you have to be very careful about the long run. Take a PFI project that still has 15 years to go. You can still buy that at around 10%, which is an interesting proposal, given interest rates at the moment. They are government-backed, long-term projects, with history, a safe fund for maintenance, and provision for problems. So these funds are very attractively priced. Will that be the case when the market is fully developed in seven or eight years’ time? I don’t think so.

AC, State Street So what are the attractive areas of infrastructure at the moment? Should people be buying into ABP and BAA? Or should they be looking at secondary PFIs?

PW, Henderson Well I’m biased, but we clearly think that secondary PFI and PPP is attractive now and will be for a while longer. But it depends what you as an investor want to get out of the investment. Relatively speaking, secondary PFI is at the lower risk, lower return end of the infrastructure scale.

HM, ABN Amro Yes, but you still have equity risks. You still have life-cycle costs. You have all sorts of issues that might hit you suddenly when something goes wrong and you have to fix them.

RC, ABP You have to have your equity risk premium, but it is certainly a different risk characteristic than during construction, and certainly different from when you talk about companies like BAA, where there’s also company risk.

The role of regulation

AC, State Street Does being regulated define an infrastructure investment? Would you only invest in regulated industries?

RC, ABP It must be regulated or a near-monopoly. We don’t like commercial risk.

CM, Standard Life It certainly helps if it’s regulated, but regulation doesn’t completely remove political or legal risk, it just normally creates a more stable framework. The key thing is to be able to form a long-term view of the revenue streams and their stability and if their risks are too high, these investments get very hard to price. We’ve seen in Asia that sovereign risk and over-reliance on a particular regulatory environment can get you into trouble. If you make a mistake in a politically risky environment, you can lose just as much in infrastructure as you can in anything else.

PW, Henderson You can see how important regulation is to infrastructure investors by looking at airports. Airport businesses have become expensive relative to their pure infrastructure component, because airports are effectively three businesses. There’s effectively the runway, the regulated bit; the terminal, which is sometimes regulated, sometimes not; and then you’ve got all the retail and the car parking, which often isn’t regulated at all. Sometimes they’re all in the same pot together and that regulatory framework can make a big difference to how attractive an airport is. There are differences in airport valuations around the globe, which comes down to the different regulatory structure in each country.

Why now?

AC, State Street Why has infrastructure investment taken off now?

RC, ABP Investment opportunities. Ten years ago on the equity side of infrastructure there were only opportunities in Australia and maybe a couple of projects in the other countries, although on the project finance side, it was a different story.

HM, ABN Amro But even the project finance market was limited. There were few project bonds and the bank market was open or shut depending on what the projects and markets had done. The advent of investment-grade project bonds has changed that.

CM, Standard Life Traditional high-yield investors were used to looking at subordinated issues from companies. However, looking at senior debt but in a high-yield project finance infrastructure deal is different and investors needed to get used to that. And also through the use of securitization and monoline insurance there has been an increase in the amount of high-grade infrastructure-related paper available. A good example is Anglian Water, a regulated water company, raising more debt than a traditional water company by using quasi-securitization techniques, but in the end you haven’t got the hard assets because of the regulatory regime.

PW, Henderson Single asset, whole business securitization only started to develop in the early-to-mid 1990s, following privatizations in the UK, Australia, New Zealand, and a few other places. They borrowed from US mortgage-backed securitization market techniques which were unfamiliar to investors elsewhere. But what has made infrastructure on the equity side more popular is greater investor sophistication – looking at this as a separate asset class – and greater certainty of deal flow that fits the performance characteristics.

HM, ABN Amro That has been the sea change really. You need to see both sides and you need end deal flow.

Inflation hedge or liability match?

AC, State Street Do you think of infrastructure investment as an inflation hedge? Or is it an asset/liability-matching asset?

RC, ABP For us it is asset/liability matching. According to our research into the equity side of infrastructure, there’s no inflation match. Refinancing takes all the inflation characteristics out, because of a hiccup in the way part of your capital is repaid.

PW, Henderson So it’s only if you buy straight after a refinancing, and hold, that you gain that liability matching from an inflation point of view.

RC, ABP Yes. But on the other hand, looking at the overall characteristics of an infrastructure project, it is long term and there is an inflation component in the cashflow stream, and therefore for us it is an inflation/liability match.

PW, Henderson You can’t say that buying a port company has the same inflation matching characteristics as buying a concession to build a dock, so even within almost identical types of asset you can have different cashflow characteristics.

What to buy in PFI

AC, State Street What sort of PFI is attractive and what characteristics do you look for in a PFI?

PW, Henderson There is riskier PFI and there is less risky. We tend to concentrate on the less risky, because that’s what our investors want. Others in the market are targeting more risky PFI and it’s not a question of good or bad – there’s such a wide range now. You’ve also got shadow toll roads, where the government is paying the toll.

There, the risks and the volatility are not that great. People tend to concentrate on physical assets where due diligence is meaningful, and there’s a tendency to steer away from investments that are technology orientated – changing computer systems, that sort of thing.

AC, State Street And what’s going on in Europe and where are the hot spots?

PW, Henderson The good news is that PPP in Europe is starting to take off, so there is some confidence that a reasonable quality deal flow, often structured in very similar ways to UK PFI, will develop. That will be useful, because UK PFI has probably gone through its big growth phase.

HM, ABN Amro In continental Europe, France is promising, and we see as well numerous projects in the Netherlands and Italy developing in quite a serious way. So I do think there is a genuine drive to use these financing techniques for a number of core infrastructure assets. In Germany we are observing the beginning of real potential in terms of deal flow. In Spain there has been a market for some time. The construction companies traditionally provided the equity, although at a capital cost, which to date has made it less attractive to the rest of the investing community.

AC, State Street We talked about demand, but is there enough supply out there?

PW, Henderson From an investment management point of view, as an acquirer, we always want more. Supply is growing in some areas of infrastructure but not in others. And you can never rely on the secondary market – built infrastructure – because the flow is erratic.

HM, ABN Amro Yes, though it’s unclear why some of the current equity holders – construction companies for example, hang on to the equity. Why? Would it not be better for them to recycle it and use that equity for new projects?

PW, Henderson Often they have only just learnt that their equity in these investments is worth something.

CM, Standard Life Similarly on the debt financing side, it’s between the bond market and banks. Banks are very competitive at the moment, and it’s limiting supply in the bond market. Traditionally the bond markets have been more capable of taking longer-term views, probably because of the asset/liability matching side. But banks and UK PFI over the last five to 10 years have extended maturities immensely. In Europe, the PFI schemes that have occurred have been very competitive for local banks. So again, that kind of dynamic will change over time as more projects come along, and certainly in terms of financing structures.

RC, ABP There is potential for privatization where governments or local governments still hold projects on their balance sheets. The US is an area where the government may start to look at using privatization to reduce public debt.

HM, ABN Amro You’re absolutely right, that has prompted the sudden interest in the United States, because some of these assets achieved record prices for states and mayors who woke up and said: “Why don’t we sell our bridge, for instance? It’ll solve some of our financial problems.”

PW, Henderson And in this benign debt market, they don’t have much balance sheet capacity left, and the differential in pricing in terms of the debt side has almost disappeared. That certainly had a big impact on the US. It could have a big impact over time in Germany.

HM, ABN Amro Although in the US you always have an issue with how strategic an asset is. Take the recent US ports issue, for example.

RC, ABP Sure, but if CalPERS and the other big pension funds start investing heavily in infrastructure, that will no longer be an issue.

How to buy infrastructure

AC, State Street How does one invest in these assets? Is the best route through funds? Is the best route co-investment? Is it debt? Or equity?

RC, ABP ABP started by investing through funds where you have what we call “strategic partnerships”, in other words a fund where you have more than one relationship you can depend on. You then have co-investment rights and try to co-invest alongside that fund, not actively participating in the due diligence or the SPV management and so on, but as a passive co-investor. That’s the structure we chose. We built up our internal knowledge and team with a view to deciding whether to stay as co-investor or to invest directly. We developed strategic partnerships with a limited number of funds, and then decided on each co-investment opportunity on an individual basis. Doing it this way means we are in a position to put more money to work, because if you only do it through funds, you need quite a lot of funds in order to have a reasonable amount of money invested.

PW, Henderson It’s often a scale of fund issue. There are large pension funds that, like you, look at everything top-down before even making a decision in the sector. Most sophisticated pension funds are moving in the same direction as you or, in the case of Canada and Australia, have already got to the point where they’re active co-investors.

HM, ABN Amro Oh yes, very active in some cases, although as Robbert says, you need the knowledge, the experience and the team in place. Each investment opportunity, by its very nature, takes an enormous amount of due diligence and time to get to the final hurdle. If you cut corners somewhere in the process, you take excessive risks. Something will go wrong and your team will then spend all their time on a work-out situation.

Also with public to private transactions, you have the sponsorship risk attached. If you make a bid for a public company that is then rejected, how does that appear in the market and how often is it sustainable that you make an approach that is not successful?

Debt or equity?

PW, Henderson There’s a big difference between equity and debt investing in infrastructure simply because there are more choices on the debt side than there are on the equity side.

CM, Standard Life Yes, from our perspective, an infrastructure debt fits neatly in a portfolio that also includes bank debt, corporate and structured debt. Then it’s a question of whether we like the underlying assets, whether we think we’re being paid for the risk and whether it suits our book in terms of liability. You can take either the public debt route or the private. With the private placement there is a lot of work, and potential deal fatigue in that you quite often get involved in the bidding but lose, because you’re competing against very competitive banks. So Standard Life investments so far has chosen buying the public debt route. You’re then constrained up to a point, but the majority of PFI as opposed to infrastructure debt has been wrapped by the monolines. It’s harder to differentiate, but we do, because the monolines only guarantee to par. Quite often the bonds have a higher market price depending on interest rates, so if it does default you potentially lose the difference between the market price and par. Some of the infrastructure issues are very attractive – water securitizations, potential transport deals and so on. You’re taking more risk but you can earn quite a nice return that way.

HM, ABN Amro One can get a nice pick-up in these areas.

CM, Standard Life That’s the idea, yes, so we own quite a lot of BBB-rated water projects. We like the idea of buying subordinated structured debt from companies such as Anglian Water and Southern Water which we believe have good risk reward characteristics.

PW, Henderson But from the point of view of selling the fund, you’re not selling infrastructure as a sector at all, are you?

CM, Standard Life We’re not, no. The majority of our clients ask us to outperform a certain benchmark, and within that benchmark there’ll be some infrastructure assets.

AC, State Street And what benchmarks are you managing against for those sorts of portfolios? Are they just internal funds?

CM, Standard Life No, it’s internal and external. We manage third-party pensions and retail money with different benchmarks depending on the risk profile of the clients. A lot of them are just against a sterling corporate index, with an element of structured debt and infrastructure or European corporates. So the question is: “Do you like the underlying asset and is it giving you more value compared to a BBB corporate?”

AC, State Street How else can you buy the sector? And is listed equity true infrastructure?

PW, Henderson There is the HSBC float here in the UK. I’m not aware of there being listed equity market infrastructure pure play opportunities anywhere else in Europe.

HM, ABN Amro Another alternative is that you buy the listed equity of a company which operates in the infrastructure space. There are plenty of large companies too choose from in this capacity.

RC, ABP This comes back to definitions. People thinking about infrastructure look for data and in terms of available long-term data, people look to infrastructure-type companies listed on a stock exchange. But as soon as you introduce an equity component the whole discussion starts off on the wrong footing. It becomes not about the investment characteristics of what we call infrastructure, but about data and data-manipulation.

PW, Henderson I’m not sure if anyone’s put together a specific portfolio of utilities. But that is a way to do it. You can create a synthetic benchmark, as Macquarie has done.

AC, State Street I think there are real-return funds which would probably be invested in those kind of assets as well as mining and things like that.

RC, ABP Yes, well Macquarie has created a theoretical benchmark on infrastructure, and that is now run by the FTSE.

A broadening market

AC, State Street Are there enough funds out there different enough to build a diversified portfolio of funds?

RC, ABP Well, infrastructure is a hot topic and more and more funds are becoming available. Investors are interested, and therefore there are always managers who want to approach the market. But if you look at the proposals, the differentiation is not that great, and in a lot of cases depends on where the manager comes from. There are private-equity managers who want to set up an infrastructure fund, but in most cases their investment horizon is shorter and they think that they can exit in two to five years. They come from a different background. We don’t normally get a fund that starts off with a 30-year investment horizon. They all build in the possibility of either extending the life or setting up a second fund, based on the fact that most investors want to have an exit somewhere. You can’t be pinned down for 30 years, because a pension fund doesn’t know what the regulatory environment will be in even 10 years’ time. This is a different approach from that of a private equity investor looking for an internal rate of return (IRR). The shorter your investment period with the same exit opportunity, the better your IRR. There’s quite a difference between doubling your money in two years or in 10. But as an infrastructure investor I’m interested in stable cashflow. I don’t look for a high IRR, because then I have to reinvest my money again. And I don’t know if will I have the same opportunities. The other thing is that we’re starting to see more country-specific funds – European fund, US fund, global funds – and there is certainly the possibility that funds will compete with each other.

HM, ABN Amro I’ve recently seen a fund concentrating only on southern Europe. There are sector-specific funds as well, dedicated to airports or to toll roads or wind farms. One issue, though, is that because some of the infrastructure investments on the equity side are quite sizeable, unless the underlying fund has a certain size you become restricted – if, for example, you only have a $100 million size fund then the underlying investment you can make will be quite small, and quite limited.

Flip or hold?

AC, State Street Do you think the private equity mindset can be applied to this market? Can you make good profits from taking the short view?

PW, Henderson Elements of what we do are very similar to what traditional private equity people do, in due diligence and in deal structuring, around how you might buy a port company against how you might buy a chain of hotels. And there are private equity practitioners who do deals that are quite similar to infrastructure deals – securitization deals and so on. It’s very difficult to be definitive, but I would agree with Robbert, if you come with a mind set saying,”We’re going to get it up above a 20% IRR and we’re going to be in and out in three years”, it won’t happen, because the deal characteristics don’t allow for it, and certainly the pricing doesn’t.

RC, ABP That’s true. Private equity firms cannot make up the right returns in their investment approach, because if your target is 15% to 20%, you cannot realistically project that in an infrastructure project.

PW, Henderson If they’re looking for really high returns, they’ll have to go into primary deals in more risky countries. The large-scale deals that fit those parameters generally can’t even be built in three years. So while some people from private equity have the right sort of characteristics to execute deals in infrastructure, it just doesn’t fit with their current funds.

RC, ABP So they then try to set up specific infrastructure funds.

HM, ABN Amro Yes, and they tend to also invest in the publicly listed market, and look to take the company private do a bit of restructuring. The water sector and the waste sectors are good examples of this.

RC, ABP The difference, though, is that private equity investors and managers want to put in enough managerial experience to enhance the price. They want to buy a company, change it, make it more efficient and then sell it again at a higher price. But in infrastructure, you can’t usually add much managerial enhancement. If you buy a waste company or a gas distribution company, it’s usually regulated. The regulator likes to see a long-term equity investor. They don’t want someone who tries to turn the whole thing around to re-sell it again in three years’ time.

CM, Standard Life From a debt perspective it’s important to understand who’s going to manage it operationally, their expertise, and the incentives for them to stay in the long term. They may be able to cut costs, but you’re really looking for long-term equity people who’ve done it before. You can never expect equity to bail you out when times get tough, because it’s non-recourse, but you should have some confidence that they will stick with you in the tough times and work with you to solve problems. Otherwise you’re probably not getting paid enough and you should be buying the equity in the first place. The debt should have greater stability because your return is a lot less.

HM, ABN Amro I think the key point is that private equity characteristics are quite quite different. As an investor, you should not expect any cash returns while you are invested, it’s purely the capital gain, while with infrastructure investments, as an investor you can expect a decent cash return during the investment period.

Benchmarking infrastructure

AC, State Street What type of benchmark should be good for infrastructure?

HM, ABN Amro I think I would look at the government 10-year rate, add an average equity premium for listed securities and a premium to reflect the illiquidity of the investment. And then the only other differentiating factor is whether you have a construction element, a ramp-up phase, or whether, indeed, it is all operational. All of which require different premia.

PW, Henderson Yes, some people have done it that way. Others have gone for a real return benchmark, and it depends a bit on how they’re doing their risk budgeting and asset allocation. I suppose there’s also an implicit long-term call on inflation.

HM, ABN Amro True. I just don’t see why if you invest in equities and/or you invest in publicly listed equities, where you have liquidity, transparent information, and where management gets scrutinized on a regular basis, if over the long term you get a certain premium, why should you expect less for illiquid infrastructure assets.

RC, ABP An equity manager will try to outperform his benchmark, whatever benchmark he has. A bond manager will try to do likewise, by buying the right issues in that particular benchmark or buying outside that benchmark, but still taking into account the risk he is running against that particular benchmark. If you have a government-plus benchmark, you are not running that risk. The manager is not looking at the bond rate and saying, “Okay I want to have bond plus two or whatever.” No. In most cases the manager is making a natural return decision. He is looking at an IRR over a long period of time with a certain cash element in it. So in my opinion, a real return benchmark is much better, because there is no relative return benchmark yet. Decisions are made on whether it provides the return that the investors have been promised.

HM, ABN Amro That’s true if I take my benchmark to be gilts and historically I have five percentage points equity premia, then I would look at gilts plus my 5% plus on top of that a premium of 2% or 3%.

RC, ABP I agree with you, but that’s not how funds do it. The fund says, “My benchmark is a certain return, a hurdle rate.” It has nothing to do with what happens in gilts. That’s a fixed benchmark and therefore real return is much easier. There’s a hurdle rate and it stays there for 10 years.

HM, ABN Amro Well it stays there for about four years because that is usually the time period you have to invest, isn’t it?

RC, ABP Okay, but after that you are still being paid against that particular fixed rate.

CM, Standard Life But doesn’t it go back to your asset allocation decisions? And then you can’t escape the benchmark. It’s, “Well, these are giving me this absolute return of 10%. I can still invest in Dutch government bonds for 9% just because that’s the way they are at the time”.

RC, ABP We try to differentiate between the strategic allocation decision, which is long term, and what you do on a three or four yearly basis.

Is real estate infrastructure?

HM, ABN Amro What about real estate? Would you look at that differently to an infrastructure fund or to a private equity fund in terms of benchmarking?

RC, ABP It is possible to have a relative real estate benchmark, when there are more funds. Someone will start collecting data and creating a benchmark.

HM, ABN Amro Yes, in the same way as has happened in private equity, and in hedge funds.

PW, Henderson Robbert, the standard distribution and performance of private equity funds is quite wide. Do you think it’ll be as wide in infrastructure? That could be quite important?

RC, ABP Because the variation is that wide, manager selection in private equity is very important, but that’s not an issue yet in infrastructure. But of course when there are more projects with more people involved, the variation in infrastructure could easily widen out as well.

CM, Standard Life I guess the test is when one or two projects go wrong, because then that must distort returns.

PW, Henderson There have been some negative experiences in the toll road sector, even for Macquarie, and from a performance rather than from a fundraising point of view. But I don’t know if a specific range of experience in, say, ports, would enable you to learn very much about the future range of outcomes.

CM, Standard Life What was the data like, though, for those who invested in US power, which obviously did have its problems, or for Asian infrastructure? Was it so opaque that you couldn’t draw conclusions about different managers’ abilities then, or was it just that there weren’t sufficient managers from whom to draw comparisons? Those are two areas that have gone through a cycle of good times and bad times. Private equity is dispersed in the bad times, just as much as in the good times, and presumably it will be similar for infrastructure.

PW, Henderson In Asia, it was very concentrated. You’re talking about maybe five, six funds. Some forgot about their investment strategy and went heavily into telecommunications, very badly. But the others, even though they probably didn’t invest more wisely, did stick to the basic infrastructure they knew. While they went through a very bad patch, the value of those investments has recovered in the last couple of years, so by the time they’ve held them for an appropriate duration, they’ll probably look like quite reasonable investments.

On a risk-adjusted basis, having gone into those funds in Asia compared with doing the same thing in Europe, I doubt whether they’ll have earned enough to recover that additional risk. Managing infrastructure investments is often more about making sure they don’t go wrong, rather than trying to make some fantastic multiple out of them. And if you buy them for the wrong price at the wrong point in the cycle, there is no way back. It’s not like private equity, where changes in a sector’s rating or a trade buyer play may help you out of a hole.

Picking managers

AC, State Street Is it easy to identify manager skill?

RC, ABP We put a lot of effort into two things. First, the managers’ experience. The problem is there are not many managers who have much experience in infrastructure itself. However, there is a lot of experience in project finance, so you try to get an idea of how good they are at structuring deals and structuring deal flow. Secondly, can they access deal flow? Do they have the right set-up, the right organization? Because although there are a lot of opportunities, not all these opportunities will be auctioned so that everybody can access them. You need to have an organization behind the manager to get access to the deal flow, and that’s very important.

HM, ABN Amro In the infrastructure space, many projects have a lot of complex structuring issues, particularly when they are being built, which by its very nature somewhat limits the number of players who can provide this service.

PW, Henderson And it’s not simple because they can’t just sell to anyone. Even with BAA there’s a subtle set of constraints around the acceptability of who’s going to manage and operate that business, regulatory issues in terms of debt and debt structuring, and certain people will undoubtedly have an advantage in terms of their ability to understand and work with the regulator and to provide better or more acceptable solutions than others. So the competition for deals is subtly different. The bigger deals in any market these days are likely to be some type of auction. But in infrastructure there are restrictions as to when you can sell and under what circumstances.

HM, ABN Amro And to whom you can sell. In the gas and water sectors there are certain limitations as to who can buy.

AC, State Street Finally, what about newer markets? Is there an extra premium to holding emerging market infrastructure over other infrastructure?

PW, Henderson It’s easier for the debt markets to enter those developing markets than it is for equity. They’ve got some international protections, and the World Bank knows how to pressurize to help protect bonds. It’s much more opaque from an equity point of view.

HM, ABN Amro That’s true, because governments have a position to protect. The countries in question want to maintain their reputations in the international debt markets, almost at all costs – the equity provider, on the other hand, well, he took equity risk and is fair game.

CM, Standard Life But do you buy the government debt of a developing country, where the incentives for it to maintain its obligations are very high, or do you buy a water project where there’s legislative and regulatory risk and a whole series of other complexities. They’d be expecting quite a large premium between the two. Even then, of the projects that have gone wrong in emerging markets, either the sovereign’s collapsed anyway, so if you’d owned the sovereign debt you’d have lost money, or there has been legal, political and regulatory risk. So buyer beware. You have to do a lot of due diligence. There are markets where it’s just too risky for the return offered.

PW, Henderson So if a market’s not open to the international debt markets, it’s not going to work for infrastructure equity. I’m sure people will make money in central Europe, but you will need a team that is knowledgeable about those countries, and with real infrastructure experience

RC, ABP Yes, but infrastructure is just behind private equity. It took 10 years for private equity to move into emerging markets. Up until four, five years ago, there was hardly anything happening, but now of course all the big names are there, and the same thing will happen with infrastructure. Once they have the experience with funds in Europe, the US and Canada, they will start looking for opportunities elsewhere. It’s still early days. There are local funds active in India, but that’s a different story.

AC, State Street Well, that’s all we have time for. Thank you all very much.

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