Investing in Infrastructure – Combining Responsibility with ReturnsPresentation Transcript
Redington13-15 Mallow StreetLondon EC1Y 8RDT. 020 7250 3331www.redington.co.ukTUC Member Trustee Network Annual Conference 2011Investing in Infrastructure – Combining Responsibility with ReturnsNovember 15th 2011
2Investing in Infrastructure – Combining Responsibility with ReturnsWhy invest in infrastructure?• Earn high-quality, long-dated inflation-linkedcashflows at attractive real yields• Obtain returns no longer offered by traditional assetclasses• Reach full funding with lower risk• Support projects which provide high value add forsocietyWhat to consider when investing?• How will you access infrastructure returns: Choosing the right structure to make infrastructureFlight Plan Consistent What are the advantages of bespoke investmentstructures? Which risk profiles are acceptable?Which opportunities are available?• Wide range of attractive opportunities with differentrisk/return profiles, such as: Social housing Private Finance Initiatives Water infrastructure
3.03.54.04.55.05.5Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11%30-year gilt yield30-year swap rateThe markets we are in: declining yieldsLong-term yields have fallen, pushing up thevalue of pension funds’ liabilities...Why Invest in Infrastructure?The markets we are in31Source: Bloomberg, Redington31-Oct11
406080100120140160Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11RebasedatJan07=100FTSE 100Emerging markets equity*Developed world equity**4Why Invest in Infrastructure?The markets we are inThe financial crisis has set equities on a rollercoaster ridewith low and volatile medium and long-term returns. Riskyassets have increasingly failed to deliver adequateoutperformance.2Source: Bloomberg, RedingtonThe markets we are in: underperforming equities*Emerging market equity = MSCI Emerging Markets Index**Developed world equity = MSCI Developed World ex. UK31-Oct11
-0.2500.250.50.7522.214.171.124Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11%Yield on 30-year inflation-linked gilt30-year real swap rate5Why Invest in Infrastructure?The markets we are inSource: Bloomberg, RedingtonReal yields have declined, making it more difficult forpension funds to access attractive and secure long-term returns that will allow them to reach full funding.3The markets we are in: low real yields31-Oct11
75%85%95%105%115%Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11FundingLevel(Assets/Liabilities)Funding levelFull funding250300350400450Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11£bnAssets LiabilitiesThe effect on pension schemes: declining funding levelsWhy Invest in Infrastructure?The effect on pension schemes1. Falling long-term yields 2. Risky assets underperforming 3. Declining real ratesFTSE 100 companies’ aggregate pension assets and liabilities Aggregate funding level of FTSE 100 pension schemesAs asset performance failed to keep pace with rising liabilities, funding levels declined.Pension funds must therefore focus on making the right decisions to achieve full funding in a difficult environment.Source: Aon Hewitt Pension Risk Tracker, Redington Source: Aon Hewitt Pension Risk Tracker, Redington631-Oct11 31-Oct11
Full fundingGetting the returns you needCurrent positionInfrastructure assets can help schemesachieve full funding because they offer...• Attractive rates of real return• Inflation linkage• Long-dated, high quality and often securedcashflowsPension funds must find ways to:• Earn attractive long-term realreturns sufficient to achieve fullfunding• Obtain inflation-linked cashflows• Strike an attractive risk/returnbalance• Consider where you want to be positioned in the capital structure (debt or equity)• Determine the return you require and the level of risk you are comfortable with to choose theright type of infrastructure asset to invest inMaking the best of infrastructure7Why Invest in Infrastructure?Getting the returns you need
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020GBPMillionsLiabilities Path Actual Liabilities Assets Path Actual AssetsLiability BasisContributions & Asset ReturnsTime HorizonThe Flight Plan is an effective tool for making focussed asset allocation decisions and identifyingthe best opportunities.It allows schemes to identify the assets which contribute most towards their progress to fullfunding – we call them Flight Plan Consistent Assets.Why Invest in Infrastructure?Flight Plan8The Flight Plan• Maps out the path of ascheme’s assets andliabilities from theircurrent position to fullfunding• Requires three keyvariables to build: theassumed rate of returnon assets, the cashcontribution schedule,and the target date forfull funding.
9Growth“FlightPlanConsistentAssets”MatchingWhy Invest in Infrastructure?Flight Plan Consistent AssetsFuel efficiency: achieve an efficient risk/return balance
10-6-4-2024680 5 10 15 20 25 30GBPMillionsYearsInitial investmentAttractive realreturnsInflation-linkedcashflowsProviding a matchfor liabilitiesInflowsOutflowsSource: RedingtonFlight Plan Consistent Asset – Example Cashflow ProfileWhy Invest in Infrastructure?Flight Plan Consistent AssetsKey CharacteristicsFlight Plan ConsistentAssets• Enable schemes toaccess attractive realreturns and long-datedinflation-linked cashflows .• The attractive realreturns are the resultof a significantilliquidity premiumKey CharacteristicsAttractive real returns and inflation-linked cashflows High-quality, often secured cashflowsIlliquid Varying degrees of complexity/might be difficult to access
Infrastructure• Take advantage of attractive yields on long-term securedproperty leases• Yields may be in excess of yields on corporate bonds issued bysame borrower• Long-dated index-linked cashflowsSecured Leases• Ground rent created when freehold land or building is sold onlong lease• Typically “pepper-corn” rent for land only (not buildings)Ground Rents• Low-cost rental housing provided for disadvantaged people inneed of housing• Generally provided by local councils and housing associationsSocial Housing• Investing in public sector projects through, for example, PrivateFinance Initiatives (PFIs), bespoke investments structures or bypurchasing a suitable infrastructure asset• Wide range of possible assets, from roads to power generationTraditional InfrastructureWhy Invest in Infrastructure?Flight Plan Consistent Assets• Offers long-dated, inflation-linked cashflowsfrom secured borrowers (i.e. housingassociations) with quasi-governmentguarantee• Long-term, potentially inflation-linkedrevenue streams• Offers attractive returns, limited creditrisk and high level of securityOther Flight Plan Consistent Assets11
We will focus on Social Housing and Traditional Infrastructureto illustrate the different factors that need to be taken into account.• Pricing mechanism: availability vs. demand• Stage of development: infant vs. matureTraditional Infrastructure• Redington is cooperating closely with third partieswith strong infrastructure expertise and resourcesto provide attractive investment solutions forpension funds.Social Housing• Redington has been a pioneering force for turningSocial Housing into an investable asset class forpension funds.Accessing infrastructureWhat to Consider when Investing?Accessing infrastructureInvesting in infrastructure is usually relatively complex.It is essential to focus on getting the details right to ensurethat the actual returns and cashflows meet the pension fundinvestor’s expectations and requirements.Specific Risk/Return Profileof the individual asset12• Capital structure• Solution type: bespoke vs. pooledInvestment StructureUsed to access the returns andcashflows12• Social housing• Private finance initiatives• Water infrastructureExamplesof infrastructure assets3
Making infrastructure Flight Plan ConsistentWhat to Consider when Investing?Making infrastructure Flight Plan Consistent13Pension funds must be clear about the way in which they wantto access infrastructure investments.Before the financial crisis• Infrastructure investments have historically beenstructured with little equity and high levels debtprovided by banks. Pension funds often invested in theleveraged equity as a growth asset with relatively lowsecurity of returns and usually no inflation linkage.After the financial crisis• Banks have increasingly withdrawn from providing debtfinancing. Pension funds have increasingly stepped in toreplace bank financing. Smaller schemes have focussedon investing in infrastructure debt.• Large pension funds have purchased wholeinfrastructure assets (100% equity) to obtain fullownership and enjoy all benefits such as inflation-linkedand high-quality returns.• Full ownership allows pension funds to makeinfrastructure assets Flight Plan Consistent.The Right Structure to Earn the Returns You Want90% DebtWholeBusiness100% Equity10% EquityProvidedby banksPensionfundsBefore the financial crisis After the financial crisisPension fundsFlight Plan Consistent
North America• The UK’s largest pension fund – the BT Pension Scheme – hasinvested over £300m in renewable energy infrastructure.• A number of other large UK schemes, such as the UniversitiesSuperannuation Scheme (USS) and the Railways Pension Scheme(RailPen) have infrastructure allocations.United Kingdom• ABP – the pension fund for government and education employeesand the largest in the Netherlands – allocates 2% of its €242billion assets to infrastructure.• To facility this, it has opened offices in Hong Kong to gain accessto Asian infrastructure projects.Continental Europe• The largest US pension fund – the California Public EmployeesRetirement System (CalPERS) – adopted a new investment policyin 2008 with a target allocation of 3% of assets or $7.2 billion ininfrastructure.United States• The Ontario Municipal Employees Retirement System (OMERS)and Ontario Teachers Pension Plan (OTPP) are large players indirect infrastructure investment.• They succeeded in joint bid for the UK High Speed Rail 1 for £2.1billion.CanadaWhat to Consider when Investing?What other pension funds are doing• They now hold a 30-year concession to ownand operate the rail line.• Other large infrastructure investorsinclude Danish pension fund ATP, whichamong has invested in toll roads andports around the world.Europe14• As part of this strategy, CalPERS took a 12.7%stake in London’s Gatwick Airport.
Bespoke investment structuresWhat to Consider when Investing?Bespoke investment structures15Source: EvolutionSecurities, RedingtonAsset Manager• Manage day-to-day operations and supervise financial performance of eachinvestment/provide operational fund management servicesInvestment Manager• Provide financial analysis and investment,origination and structuring expertiseExample Bespoke Investment StructureInvestment Consultant• Support for evaluating and structuringinvestments• Ensure investments’ risk/return profile andinvestment structure are in line with FundrequirementsPension FundTailored Investment Structure(e.g. Fund/Special Purpose Vehicle)Development 1 Development 2 Development 3Equity/Debt InvestmentHousing AssociationPortfolioEquity Investment
Risk profilesMost RiskPricing mechanismLeast RiskSectorThe risk that an infrastructure investment fails to provideliability-matching returns depends on several factors.• An asset that earns areturn simply because it isavailable for use will beless risky than an assetwhere the return dependson actual demand• “Infrastructure” covers a wide range of different assetswhich can be exposed to a wide range of risks such as‐ availability risk‐ construction & performance risk‐ political & regulatory risk (e.g. changing regulatoryregimes)‐ environmental risk (e.g. pollution)‐ technological risk (e.g. obsolescence, technicalchallenges)• Pension fund investors must therefore thoroughly assessthe risk profile of the asset they want to invest inInfrastructure SectorAvailability Regulatory Demand Economic PriceMost RiskLeast RiskPricing Mechanism• Investors will be exposed tomore risk if they invest at anearly stage of development,but can also expect a higherreturnDevelopment StageWhat to Consider when Investing?Risk profiles16Source: EvolutionSecurities, Redington
Which Opportunities are Available?Private Finance InitiativesExample: Private Finance InitiativesPrivate Finance Initiatives are a form of Public PrivatePartnership where private firms provide funding, constructionand operations services for public sector projects.17• Contracts are long-dated and cashflows typically inflation-linked• Revenue streams backed by quasi-government guaranteesand secured on underlying assets• Illiquidity gives rise to a premium return over gilts• Large scope for socially responsible investment and creatingwealth for both beneficiaries and the wider community• Bank balance sheet contraction has increased the universe ofopportunities for pension funds to provide debt financingPrivate Finance Initiative investment featuresDefence: Future StrategicTanker AircraftHealth: Queen ElizabethHospital, LondonTypical investment structure:GovernmentPension Funds(Investors)Special PurposeVehicle (SPV)CapitalInterestpaymentsBuild & managethrough privatecontractorsCash flowgenerated fromassets
• Bought by HSBC in August 2011 (for warehousing)for £74m• Provides water for 300,000 people in Cambridgeshire• 2010/2011: Revenue of £20m with profits of £7mbefore tax with no external debt except for a revolvingcredit facility to cover working capital• Attractive purchase opportunity for a large pension fund or aconsortium of funds• Redington advised two UK schemes who bid for this asset. However,although this bid was acceptable on price, it could not compete withthe winning cash bid which had an accelerated timetable and no duediligenceWhich Opportunities are Available?Water infrastructureExample: Water infrastructureThe UK water sector provides excellent examples ofinfrastructure assets attractive for pension fund investors,providing the security, returns and cashflows that pensionfunds need.• Economic environment has small impact on returns:water is a necessity and will therefore be demandedirrespective of economic growth.• Inflation-linked cashflows and returns: water companies ‘regulatory regime means they can increase prices in linewith the agreed price review which in turn is based on aformula related to RPI.• Low regulatory risk: The regulator’s desire to increasecompetition in the area could have a negative impact onreturns but the Government is likely to block any suchmove.Water sector: key characteristicsCase study: Cambridge Water18
Which Opportunities are Available?Social HousingExample: Social HousingSocial Housing is a form of low cost, rental housing typicallyprovided by local councils and non-profit organisations calledhousing associations.19• Housing associations issue inflation-linked debt secured on apool of housing units to finance activities• Interest payments are matched by rental income that istypically increased yearly at RPI + 0.5%• Illiquidity gives rise to a premium return over gilts• Enjoys a large degree of government support, with rentalpayments often heavily subsidised• Combines social responsibility with returnsSocial Housing investment featuresBackground• Traditionally financed by state support and bank loans• Financial crisis imposed losses and higher capitalrequirements on banks, limiting their ability to lend• The government is burdened by debt and a large deficit,causing it to reduce spending• This ‘funding vacuum’ has given pension funds anopportunity to step in and provide financing
Social housing: risk profileWhich Opportunities are Available?Social housing: risk profile• The diagram shows a typicalsocial housing portfolio for apension fund investor with ablended real return of ca. 3-4%p.a.• The portfolio consists of differenthousing types with specificrisk/return profiles• By adapting the share of thedifferent housing types in theportfolio, an investor can tailorthe portfolio’s return and the riskcharacteristics so that they fitrequirementsSocial Housing is typically a low-risk asset class but the returnsand the risk on a portfolio can be tailored (to some extent) tomeet pension funds’ requirements.20Source: Evolution Securities, Redington
Redington Publications21Spring Collection Highlights: LDI 2.0, Secured Leases,Ground Rents, Equity Release Mortgages, SocialHousing, Insurance-Linked Securities, Infrastructurehttp://www.redington.co.uk/Redington/media/PDFs/knowledge/Other%20Publications/Redington-Spring-Collection-2010.pdfSpring/Summer 2011 Collection: Enhanced Matching Assets,Socially Responsible Investing and Long-Term Growth Assetshttp://www.redington.co.uk/Redington/media/PDFs/knowledge/Other%20Publications/Redington-Spring-Summer-Collection-2011.pdfKeeping up with the latest in Flight Plan Consistent AssetsRedington publications
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