On the Record: Do you invest in long-term, illiquid assets?
Matching long-term cash flow to liabilities
Ärzteversorgung Westfalen-Lippe (ÄVWL) Germany: Andreas Kretschmer, CEO
• Location: Münster
• Invested assets: €11bn
• Membership: 53,000
• Occupational pension fund for physicians in the region of Westphalia-Lippe
“When we speak about ‘long-term’ investments, we mean ones that have a time horizon of at least 10 to 20 years. On the one hand, ÄVWL strives to implement its long-term investment strategy by acting anti-cyclically through an opportunistic approach. If we believe in the long-term profitability of an asset, we intentionally accept a certain degree of volatility and price fluctuation.
On the other hand, ÄVWL is increasingly ready to enter investments with more complex structures in order to profit from extra yields in terms of illiquidity premia. This often includes arranging consortia.
Illiquidity premia can be earned by investing in long-term assets that are not marketable in the short run. ÄVWL can afford this approach due to a high level of risk capital. As a result of high reserves built in the past, ÄVWL’s risk capital comprises 23.5% of actuarial reserves, and currently we use only 37% of this quota (as of October 2014). So we have scope to continue investing in illiquid assets.
Thinking of constraints in applying a long-term investment approach, regulation is generally becoming more intense, which to an extent makes investing for the long-term more difficult. However, ÄVWL is not restricted by fixed liabilities in contrast to, for example, life insurance companies.
Furthermore, ÄVWL benefits from the fact that the yearly amount of contributions is significantly higher than the pensions we pay. Thus, we will still profit from a surplus of liquidity in the foreseeable future. Finally, as an occupational pension fund with mandatory membership, there is no lapse risk, which means cashflows are stable and predictable.
In terms of assets, ÄVWL focuses on infrastructure investments that play an important role in the economy as a whole, guarantee stable and predictable cash yields and are mostly insulated from by market fluctuations. The natural hedge against inflation that these assets offer is an added benefit.
In particular, in 2011 ÄVWL agreed to allocate 15% of total AUM to infrastructure. The current allocation is around 11% so there is room for more investments. One of our flagship infrastructure investments made in recent years was the Amprion project, where we secured a stake in one of Germany’s four major supergrid operators. We also invested in commercial loans for the construction of aircrafts and ships, as well as IT centres. These investments provide us with top-class physical securities.”
Pension Insurance Corporation (PIC) UK: Allen Twyning, Head of debt origination
• Location: London
• Assets: £12bn (€9.5bn)
• Number of pension funds insured: 105
• Specialist insurer of UK DB pension schemes
“For PIC, it is essential to find investments that provide long-dated cash flows that match our liabilities. Typically we will look at investments with cash flows spanning 30 to 40 years. That naturally leads us to consider infrastructure.
We invest exclusively in infrastructure debt, structured in a way that gives it an investment grade-equivalent rating. One key requirement for us is that the debt is non-callable.
We will not invest in infrastructure equity due to its higher risk and volatility profile. The deal size that matches our risk-return objectives is typically around £50-100m (€64-127m).
Given the nature of our business, it is a lot easier for us to control the investment process in-house rather than outsourcing it.
We invest directly rather than through funds. We will work with the borrowers’ sponsors put together a transaction that makes sense for us.
We’re drawn to relatively straightforward assets, where the construction risk is low, the cash flow is stable and the rating is investment grade. For instance, we have been involved in student accommodation projects.
In the energy sector we have looked at solar power, which is stable and able to support investment grade debt. We have also been involved in social housing transactions backed by the UK’s PFI (private finance initiative).
We have also considered regulated utilities, typically electricity distribution networks or water utilities that are already operational and capable of issuing long-dated, inflation-hedged debt that works for us. One project that includes construction risk but looks particularly attractive is the Thames Tideway Tunnel, which is expected to start looking for funding in 2015.
One of the key dynamics in this market is the mismatch between demand and supply. The government talked up a pipeline of infrastructure projects suggesting that institutional investors should become involved. But only a handful of transactions have materialised. Institutions have put together large teams, but they have struggled to deploy cash because the projects have not come to the market.
At the same time, while after the sovereign debt crisis banks pulled out of long-dated lending altogether, a number are back in the market and lending quite aggressively. I think that 2015 will be an interesting year, as we will see a real chase for assets.”
SPF Beheer, The Netherlands: Henk Hermsen, Head of investment strategy
• Location: Utrecht
• Assets: €18bn
• Membership: 100,000 participants and 100 companies
• Manager of the pension funds for the Dutch rail and public transport sectors
“Investing for the long term is among the stated investment principles of the pension funds we manage.
Therefore, the funds have room to invest in illiquid assets. The main illiquid assets classes we invest in are direct real estate, private equity and mortgages.
Both pension funds invest in direct real estate in the Netherlands but real estate is a tough market. During the past years the portfolios have been hit, as valuations have trended downwards. But in the long term we believe that the added value of holding assets directly is high, so we are gradually increasing the allocation to Dutch direct real estate.
The funds have invested in private equity since 2002. This asset class has withstood the test. Both pension funds are satisfied with the returns, despite the relative riskiness of this investment. We invest in private equity in US and Europe, selecting by ourselves funds that focus on mid-market sized buyouts.
Both pension schemes have been investors in the Dutch mortgage market for more than 15 years. The strategic allocation to this asset class is 5%. In our experience, the allocation to mortgages has proven to be a very stable return part of the portfolio. This sector has seen gradually increasing levels of regulation and major interest from the investment community. But the returns on mortgages are still attractive, and if you look at the default rates and losses, you will see that they have had hardly any impact on portfolios. However, due to heightened demand, in the future it may become a bit more difficult to source mortgage investments.
The funds are also long-term buy-and-hold equity investors. We have a very concentrated portfolio of developed market equities, with around 70 companies. We follow clear principles in the selection of these companies: they should be financially sound, with a proven business model and growing profitability. They also need to be companies that we understand, acting in a transparent and socially and environmentally responsible manner. The approach is very research intensive; a lot of time is spent analysing the companies’ business models to determine whether the long-term prospects are positive.
Therefore, even when we look at the performance of our equity portfolio, we do it against our chosen ‘liability-oriented’ benchmark that is coherent with our long-term objective. It is a benchmark that reflects the discount curve plus a premium.”
Interviews conducted by Carlo Svaluto Moreolo