Infrastructure - strong demand across the region
Infrastructure is an asset class many pension funds have looked at in the past, but have placed in the ‘too hard basket’. It is an investment not without risk. Jac Kragt, chief risk officer at the $141 billion Dutch pensions provider PGGM says, “As a pension fund, you always need to go out and make sure you receive your expected returns.” This means setting up in-house teams with expertise in infrastructure, which only the largest pension funds would be able to afford.
However, the level of activity in infrastructure investing has picked up significantly in the past year or so. New funds are being structured and quality asset coming to the market, and are being taken up by sovereign funds, family offices and pension funds, many of them from Asia.
Infrastructure investments represent a golden opportunity for pension schemes looking for a liquidity premium, according to Aberdeen Asset Management. Mike Turner, head of global strategy and asset allocation at Aberdeen, says: “For the pension schemes that can take a longer-term approach when it comes to liquidity premium, infrastructure offers a large pipeline of opportunities, with yields of 6%.”
Turner also highlights that governments and local authorities are now backing infrastructure projects, so the asset class could be seen as part of the solution to the debt crisis. “In the UK, the government, which remains cautious about the country’s AAA credit rating, is currently talking about certain assumptions that can be made about unfunded public sector pension scheme liabilities. So the question is, could they fund these liabilities by issuing debt that would not necessarily impact their credit rating and then transfer it to pension schemes? Ultimately, if they do so, this will mean the deficit is helped and private sector pension schemes could also get engaged.”
Australian asset manager AMP Capital has been behind a number of new infrastructure asset sales in 2011 and expects this trend to continue in 2012. AMP is the investment manager behind the Irish Infrastructure Trust, which is seeking up to $1.4 billion from global institutional investors. The target investments include those designated for disposal by the Irish Government and Irish commercial State enterprises, with some new infrastructure projects in Ireland being added to the mix.
Anthony Fasso, chief executive of AMP Capital Investor’s international operations says “This development is further evidence of the rapidly growing trend by pension funds and government investment agencies to substantially increase allocations to infrastructure as a means to better match long term liabilities.”
He added, “The attractiveness of real and stable assets in an environment with potential inflationary pressures has increased awareness of the investment opportunities provided by infrastructure to provide stable long term yields with the potential for capital growth.”
Driving some of the fundraising for infrastructure investment has been a pick-up in interest from Asian institutional investors, particularly from Japan and China. Fasso expects Chinese institutional investor interest to pick up in the next year or so due to a recent regulatory change that will allow Chinese life insurance companies to invest directly into infrastructure and other assets.
In 2010, the China Insurance Regulatory Commission released a series of new regulations, broadening the investment scope of insurance funds, including investment into direct assets. Under current regulations, life insurance companies have been limited to investing in infrastructure largely through loans, bonds and some equities.
In addition to Chinese interest, AMP is also seeing a big pickup in interest from Japanese institutional investors, Fasso said. Driving this interest is another rule change. Starting in 2012, Japanese companies will be required to report the funding gap for pension funds in profit and loss statements. Up to now, Japanese institutional investors have been minor investors in infrastructure: “but now they are forced to look at it.”.
The A$43 billion AustralianSuper fund has about 28% of its balanced portfolio in unlisted assets. Of those assets, infrastructure comprises 13%, property 10.4% and private equity 4.5%.
“Unlisted assets, which are a key component of the portfolio because of their diversification characteristics, have performed pretty well,” says CIO Mark Delaney. The assets are consistently delivering returns of between 8% and 10% after a downturn in 2009, when valuations caught up to spiralling equity markets across the industry. However, AustralianSuper didn’t invest in the highly-geared unlisted assets which were brought down by the GFC. “One really clear lesson out of the GFC is you don’t go chasing extra returns by taking on more risky unlisteds,” say Delaney.
The market demand for suitable infrastructure investment is being fulled also by an available pool of capital from Gulf-based sovereign wealth funds. Yakub Bobat, global head of HSBC Amanah Commercial Banking, says, “Islamic finance has a propensity toward core values in financial products, but we need to be thinking about new frontiers, including risk-sharing products and project finance.”
He indicated that Islamic investors are well placed to capitalise on infrastructure investment opportunities in high-growth emerging markets, including China, because one of the key tenets of Islamic finance is that investments must involve a physical asset.
He also pointed to a relative price advantage for Shariah-compliant finance, pointing to a HSBC Amanah capital-raising for an Islamic bond that came in 20 basis points cheaper than in conventional markets.
Malaysian Islamic financial products are broadly believed to be more flexible than those originating in the Gulf, which contributes to an increase in the size of the market, but not necessarily to universal cross-border acceptability.
However, Afaq Khan, chief executive of Islamic banking at Standard Chartered, predicts that non-Islamic counterparties would increasingly factor in Islamic requirements, as these effectively became a condition of trade.
“Every chief financial officer should be excited. This isn’t an arbitrage opportunity that happens on the market from time to time. It’s a stable source of capital looking for diversification and a balanced return.”
Unequal regulation - especially on tax - remains a potential obstacle to greater Islamic participation in the global infrastructure market. Khan said benevolent treatment would be necessary to encourage capital inflows. “These are institutional players,” he said. “When they do their investment-horizon analysis, they want to see their capital is safe and treated equitably.”