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Revisiting Infrastructure - Does It Still Make Sense For Pension Scheme Investment?

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  • 1. Private & Confidential Investing in Infrastructure 24 June 2014 1 REVISITING INFRASTRUCTURE – DOES IT STILL MAKE SENSE FOR PENSION SCHEME INVESTMENT ?
  • 2. Private & Confidential Investing in Infrastructure 24 June 2014 Investing in Infrastructure – everyone’s doing it! 2 Friends Life • £500mn mandate with Met Life • To invest in UK-based senior secured bilateral loans • To back UK annuities • Met Life also backed by other UK mid-sized insurers Lancashire County Pension Fund • £12m bond in community-owned solar power station in Oxfordshire • Part of debt financing for project • Index linked debt with a 23-year repayment period Universities Superannuation Scheme • £5bn bid for Severn Trent • Also involved Kuwait Investment Office and Borealis Infrastructure • Largest direct investment by British pension fund in UK infrastructure Devon Council Pension Fund • £40m in Aviva Investors’ Returns Enhancing and Liability Matching funds • 50/50 investment in REaLM Infrastructure Fund and REaLM Ground Rents Fund • Long-dated investments with inflation protection BT Pension Scheme • Minority equity stake in Thames Water • Shareholding in Kemble Water Holdings Limited • Illiquid investment with a natural link to UK inflation Stanhope Pension Trust • Large mandate with Allianz Global Investors • Investing alongside Allianz and EIB • Part-funded M8 motorways improvement project in Scotland via new PFI debt • First investment of this kind by a UK pension fund
  • 3. Private & Confidential Investing in Infrastructure 24 June 2014 Benefits of allocating to infrastructure debt – higher spreads (but falling) 3 0 50 100 150 200 250 300 350 400 AssetSwapSpread BAML £ Corp & Collateralised Liquid corporate bond spread as of 9 May 2014 = 118bps Approximate premium over liquid bonds = 75bps Approximate return on core infrastructure = 193bps Approximate return on opportunistic investments = up to c. 240bps, case by case Comparison of Pricing on Private Infrastructure Loans vs. BAML £ Corp & Collateralised
  • 4. Private & Confidential Investing in Infrastructure 24 June 2014 Benefits of allocating to infrastructure debt – lower default experience 4 Default Rates on BBB-rated infrastructure debt are consistent with those experienced in A-rated corporates Furthermore, ultimate recoveries on defaulted debt average 80%, and in 65.3% of cases defaults were restructured without loss. The takeaway is lower default losses than the BBB-rating would suggest. Source: AllianzGI and Moody’s
  • 5. Private & Confidential Investing in Infrastructure 24 June 2014 Benefits of allocating to infrastructure debt – role in a terminal portfolio 5 Corporate Bonds Direct Lending Corporate Linkers Infrastructure Debt Long Leases / Ground Rents Gilts Cash
  • 6. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – availability 6 “Despite having dramatically improved capital ratios in the past four years, European banks are not done yet, with many ratios below their long-term target or requiring improvement because of transitional rules. As shown, the average Basel 3 Common Equity Tier 1 (CET1) Ratio* is now within 50bp of the average target, although these targets continue to go up… …From a creditor perspective, the continued bolstering of European bank capital is the primary positive fundamental force affecting bank fundamentals.” Source: Barclays Research, ‘European Banks – Three Dimensional Capital’, 25 November 2013 * The CET1 Ratio is the ratio of the most junior form of capital available to absorb losses (typically common equity and retained earnings) versus risk-weighted assets. 0% 5% 10% 15% RBS HSBC Lloyds UBS Credit Suisse DB Commerzbank BNP SocGen Credit Agricole Santander BBVA Unicredit Intesa SP Goal CET Ratio European Banks’ CET1 Ratios: Progress vs. Goals** ** Goal is stated company target or Barclays expectation.
  • 7. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – competition for assets 7 “AXA's plan to invest EUR10bn over the next five years is the most significant so far from a European insurer. Other insurers that have recently announced investment plans include Ageas and CNP Assurances, which have both signed deals with Natixis to co-invest in infrastructure debt, and Allianz Global Investors who set up an infrastructure debt platform.” Source: FitchRatings, 19 June 2013 “The RBS Group Pension Fund has allocated an initial 750 million British pounds (US$1.2 billion) to Hastings Funds Management to manage and develop private market infrastructure assets” Source: Wall Street Journal, 17 July 2012 “Aviva and Legal and General are among the six insurers that have agreed to collectively invest £25bn in UK infrastructure over the next five years” Source: Professional Pensions, 5 December 2013
  • 8. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – political uncertainty 8 Budget 2014 widely seen as offering limited visibility of future pipeline: • £140m for flood defences • £200m for potholes • Guarantee of £270m for Mersey bridge • Up to £200m for Ebbsfleet Garden City • £100m for Greater Cambridge • £20m for Cathedrals
  • 9. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – regulatory uncertainty 9 The FTSE 100 company said sales of annuities, which allow pensioners to convert retirement pot into income, had fallen by half since the chancellor unveiled the shake-up in the budget six weeks ago. Source: Financial Times, 30 April 2014 Greater Flexibility at Retirement for DC Pensioners Decrease in Demand for Annuities Decrease in Demand for Long-Dated Assets by Annuity Providers More DB Members Shift Retirement Savings to DC Schemes Liquidity Issues for DB Schemes & Decreasing Demand for Long-Dated Assets Mitigating factors for infrastructure debt: • Active secondary market. • Many deals in <20yr maturity bracket, hence not always ultra long-dated. • Loans are often amortising. • Bulk annuity market remains robust. Potential Implications of the End of Compulsory Annuitisation
  • 10. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – time to invest 10 Factors Decreasing Deployment Time: • Wide coverage of borrower universe • Direct origination capability • Global mandate • Few concentration limits • Manager has full discretion Factors Increasing Deployment Time: • Restricted to certain borrower types • Secondary portfolio only • UK-only • Strict portfolio concentration limits • Manager needs sign-off for each deal Away from certain high- profile failures, we are aware of several investment platforms which are functioning strongly and have succeeded in putting capital to work in senior debt. Broadly, we would consider a period of c. 12-18 months sufficient to invest a portfolio of £200m+ across 7-10 assets in both bilateral transactions and greenfield projects.
  • 11. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – what is the right approach? 11 Primary Bilateral Transactions Secondary PFI Primary PFI Target Return Higher Lower Medium Origination Fee Yes No Yes Speed of Execution Slower Can be fast if seller can be identified Slower Flexibility over Deal Structuring Yes No Yes Prepayment Protection Usually negotiable No Deal Dependent Construction Risk Buy-out friendly? Deal Dependent Generally Typically Not No Yes Sometimes
  • 12. Private & Confidential Investing in Infrastructure 24 June 2014 Challenges of allocating to infrastructure debt – the various access options? 12 Independent Managers Insurance Parents Bank-Owned Infrastructure Equity Background Smaller Start- ups • Many solution providers are managers with a significant insurance background, or banks, seeking to find institutional partners to help them overcome the various Basel III challenges to holding long-dated infrastructure debt on the balance sheet. • A number of providers come from an infrastructure equity background (many of these are Australian in origin) and there are also a number of smaller start- ups, typically formed by bank infrastructure teams seeking a new home. • We feel that given the long-dated and illiquid nature of infrastructure debt assets, the corporate stability and longevity of an investment platform is key.
  • 13. Private & Confidential Investing in Infrastructure 24 June 2014 13 Conclusion
  • 14. Private & Confidential Investing in Infrastructure 24 June 2014 Does Infrastructure Debt Still Make Sense For Pension Scheme Investment? 14 • Infrastructure debt makes sense for pension scheme investors. It offers many attractive features, including: • Liability-matching characteristics • An illiquidity premium over comparably-rated corporates • An appeal to buyout providers if structured correctly • The market is moving fast and allocating is not trivial – allocations should be made via a specialist manager with a strong understanding of the client’s goals in allocating to the space.
  • 15. Private & Confidential Investing in Infrastructure 24 June 2014 2-6 Austin Friars, London EC2N 2HD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk Contacts Pete Drewienkiewicz Head of Manager Research Direct Line: 020 3326 7138 pete.drewienkiewicz@redington.co.uk 15 Disclaimer For professional investors only. Not suitable for private customers. The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf. Unless otherwise stated, any pricing information in this document is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs. Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence. This presentation may not be copied, modified or provided by you , the Recipient, to any other party without Redington Limited’s prior written permission. It may also not be disclosed by the Recipient to any other party without Redington Limited’s prior written permission except as may be required by law. “7 Steps to Full Funding” is a trade mark of Redington Limited. Redington Limited is an investment consultant company regulated by the Financial Conduct Authority. The company does not advise on all implications of the transactions described herein. This information is for discussion purposes and prior to undertaking any trade, you should also discuss with your professional, tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect of tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate. Registered Office: Austin Friars House, 2-6 Austin Friars,, London EC2N 2HD. Redington Limited (reg no 6660006) is registered in England and Wales. ©Redington Limited 2014. All rights reserved. Investment Consultancy of the Year 2014 Investment Consultant of the Year 2013 Investment Consultant of the Year 2013 Best Investment Consultancy 2014 Risk Management Firm of the Year (2012); Investment Consultant of the Year (2013) European Pensions Awards Investment Consultancy of the Year 2014