Ireland: For better or for worse
Iain Morse outlines how the NPRF has fared over the last year
Ireland’s National Pension Reserve Fund (NPRF) has been given a key role in supporting the country’s economic recovery. Put another way, the NPRF is being ram-raided by politicians desperate to find money they can spend in a manner so far from the NPRF’s original constitution that relevant legislation is needed to permit this change of use. There is nothing much new about this; similar methods have been used in other EU member states.
“We are waiting for the relevant legislation,” says Eugene O’Callaghan, a director of the NPRF. “Legal changes are required to permit the NPRF to go overweight in Ireland and in unlisted securities.” In fact the NPRF has little autonomy – it is effectively controlled by the department of finance and thereby the government.
The NPRF has already been used to support the Irish banking system. Approximately 57% of its €14bn assets are so-called ‘directed’ investments. This means they need not be invested in the best long-term interests of beneficiaries using industry-standard practices on asset allocation. Instead, they have been used to make ‘public policy investments’ into ordinary shares and preference shares in Allied Irish Banks (AIB) and Bank of Ireland (BoI). Since 2009, the NPRF was directed to invest no less than €20.7bn into these; €4.7bn into BoI, purchasing 15.1% of issued share capital, and €16bn into AIB, where the fund owns no less than 99.8% of the BoI’s issued shares.
The NPRF’s stated investment goals have been re-jigged to accommodate these types of investment. The cost to be met by the NPRF, partly or wholly, is the future cost of social welfare and public pensions between 2025 and 2055. Another objective, albeit supplementary, is to outperform the cost of government debt on a 75% probability level.
The Irish Association of Pension Funds has already gone on record with the view that there will be further substantial losses in the directed portfolio. You have to be a big believer in the future of Irish financial services sector to think that these holdings are anything but sub-optimal. The department of finance will no doubt argue that a long-term perspective is required and that the alternative, such as a BoI collapse, would only have been worse. Only time will tell.
The ‘discretionary’ portfolio still exists in its more or less original form. Approximately 40% of this is invested in quoted equity, below the fund’s strategic benchmark, an indication that portfolio re-balancing has already begun. Some 21% of assets are invested in bonds and cash, with a hefty 36% in alternatives such as private equity (12.8% of the total) and infrastructure (6.2%). On top of this there are holdings in equity options. “Within a mandate to change the fund we have de-risked while still in real assets, selling equities to buy options,” adds O’Callaghan.
The options are being used to preserve capital while the portfolio moves away from its existing benchmark. As yet there is no sign of a new benchmark clearly stating performance targets for the putative new investments to be held in the discretionary side of the portfolio. In the latest published data, from 1 January to 30 September 2012, the discretionary portfolio returned 5.9%, while the directed portfolio returned only 3.5%.
What we do know about the new investments to be made by the NPRF is that they cover a potentially very wide range; small-to-medium size enterprises, high-tech start ups and fledgling, green infrastructure such as wind farms. On top of this comes traditional infrastructure previously supplied by the state, such as roads, now spun out as toll income-generating privately owned assets. The NPRF has been investing in these since 2010, when it committed €30m to two venture capital funds run by DFJ Europe, in support of the Innovation Fund Ireland.
The department of finance has not as yet indicated any duration for these new investments or the new portfolio as a whole. Most private equity has a five-to-10-year cycle, with returns measured by an internal rate of return (IRR). There is no stated strategy to shift the portfolio back from an Irish to a global weighting at any future point.
The structure of NPRF’s participation with third-party investors is clearer. The NPRF invests via a special investment fund (SIF) but this is little more than a virtual entity, an umbrella concept. It divides into sub-funds, some already created, others as yet to be so. In 2011, the largest of these funds, the Irish Infrastructure Fund attracted €250m from the NPRF and commitments of up to €750m from both AMP, the Australian infrastructure group, and Irish Life.
The fund focuses on Irish domiciled infrastructure assets subject to privatisation by the Irish government, a smaller number of privately owned ones and new infrastructure projects. In July 2012, for instance, the IIF took a controlling share, equal to 75% of equity, in a portfolio of 10 Irish wind farms from Viridian Group. Other pipeline investments for 2013 are government owned; essentially the IIF is being used as a means to ‘privatise’ these, which include the Irish Gas Board, the ESB, which supplies electricity, airports, sea ports, and toll roads.
The government is committed to selling at least €2-3bn in assets of this kind. To get a sense of scale, this amount is several times less than the decline in value of the NPRF since the mid 2000s. Privatising state-owned assets via the IIF may be expedient and more politically acceptable than selling off the assets to the highest bidder.
The NPRF’s other important tie-up has been with Silicon Valley Bank (SVB), which ‘plans’ to lend up to $100m (€76m) to the Irish ‘innovation sector’ over the next five years.
Meanwhile, the NPRF is reported to have invested $50m into technology funds run by the SVB in what has been described as an ‘unrelated’ transaction.
December’s budget statement contained a number of measures intended to stimulate the Irish SME sector, measures that need to be read together with the future strategy for the NPRF.
The limits on expenditure eligible for research and development tax credits will be increased, and there will be additional corporate tax relief for start-ups. The Credit Review Office, which facilitates SME borrowing by helping borrowers, will be reinforced.
The most important measures are the establishment of a microfinance fund, with €40m to invest over five years, a loan-guarantee scheme, with €150m over three years, and Enterprise Ireland with €200m in 2013. The European Investment Bank and European Investment Funds are also expected to make €80m available.
In this context, the NPRF launched three SME support funds worth €850m in early January. Managed by BlueBay Asset Management, Better Capital and Carlyle Cardinal, the three funds will, respectively, offer credit lines, act as equity investors and buy out and restructure companies. The NPRF itself will commit up to €500m from its own assets, with the final amount currently dependent on the level of third party investment the BlueBay fund, expected to go live in the second quarter of 2013, can attract.