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Real assets


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As the need for investment in infrastructure continues to grow, private sector financing for infrastructure projects has developed around the world. Given the long-term growth and (potentially) low correlation aspects of infrastructure investments, pension funds have also shown interest in increasing their exposure to this area, along with their move into alternative assets. Such investments cover a wide spectrum of projects: economic infrastructure such as transport or energy producing plants, to social projects such as hospitals or schools.

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Real assets

  2. 2. December 2010IntroducPon   Akuo  Investment   •    Pension   Funds   are   increasingly   moving   into   new   assets   classes   in   research   for   yield:   they   are   looking   for  new  sources  of  return  and  beNer  diversificaPon  of  investment  risk.   •   Infrastructure  is  one  type  of  investment  being  frequently  discussed,  given  its  potenPal  to  match  long-­‐ term  pension  assets  and  provide  diversificaPon.   •    Previously  pension  fund  exposure  to  infrastructure  has  been  via  listed  companies  (such  as  uPliPes),   or  via  real  estate  porYolios.   •   However,  some  larger  funds  globally  are  beginning  to  invest  via  private-­‐equity  funds,  or,  occasionally,   even  directly.   •    In   the   1990s,   strong   stock   markets   were   supporPve   of   the   development   of   funded   pensions,   and   the   allocaPons  to  equiPes  were  increased  by  pension  funds  in  many  countries.  However,  the  burst  of  the   TMT-­‐  bubble  in  the  early  2000s  and  the  subsequent  recession  led  to  substanPal  funding  and  solvency   problems  for  pension  funds.  Both  sides  of  the  balance  sheet  were  affected.  This  led  to  a  major  rethink   of  the  asset  allocaPon  of  pension  funds.   •    Pension   Funds   enlarged   their   investment   universe   to   include   corporate   and   high   yield   bonds,   and   invested   more   money   internaPonally,   including   in   emerging   markets.   In   addiPon,   the   investment   industry   started   to   offer   new   or   alternaPve   asset   classes   for   pension   funds.   They   include   hedge   funds,   commodiPes,   private   equity,   currency   and   tacPcal   asset   allocaPon   overlays,   commercial   loans,   infrastructure  investments,  forestry  products,  microfinance  and  other  niche  areas.     AKUO  INVESTMENT  MANAGEMENT   2  
  3. 3. December 2010Infrastructure   Akuo  Investment   •    The  idea  of  invesPng  in  infrastructure  seems  to  strike  a  chord  with  many  pension  plan  directors  and   members.   Infrastructure   feels   more   tangible   and   real   than   a   lot   of   other   complex   products   and   derivaPve  strategies  presented  to  pension  funds  these  days,  where  they  find  it  difficult  to  detect  the   underlying  value.   •    In   addiPon,   infrastructure   is   made   for   the   long   term,   and   there   seems   to   be   a   natural   fit   with   the   long-­‐term  liabiliPes  of  many  pension  plans.  For  some  people  there  is  also  a  connotaPon  to  sustainable   or  socially  responsible  invesPng,  which  is  an  increasingly  popular  route  chosen  in  parPcular  by  public   and  industry-­‐wide  pension  plans.   •    In   a   historic   perspecPve,   private   financing   of   infrastructure   is   not   new.   In   recent   Pmes,   however,   there   have   been   significant   new   developments.   In   post-­‐war   Europe   in   parPcular,   most   of   the   infrastructure   was   owned   and   controlled   by   state   insPtuPons.   Since   the   1980s,   the   trend   has   reversed   as  many  pieces  of  infrastructure  have  been  (partly  or  fully)  privaPzed  in  the  face  of  stretched  public   finances.     •    The   requirement   for   beNer   infrastructure   seems   obvious   everywhere   in   the   world.   Infrastructure   investment   will   need   a   huge   amount   of   capital   in   the   coming   decades,   whether   public   or   private.   EsPmates   made   by   supranaPonal   insPtuPons   for   global   infrastructure   needs   run   into   the   dozens   of   trillions.   AKUO  INVESTMENT  MANAGEMENT   3  
  4. 4. December 2010Infrastructure   Akuo  Investment   Infrastructure  assets  are  tradiPonally  defined  by  their  physical  characterisPcs.  One  can  split  them  into   two  main  categories,  and  a  range  of  sectors  within  those:   Economic  infrastructure   •   Transport  (e.g.  toll  roads,  airports,  seaport,  tunnels,  bridges,  metro,  rail  systems)   •   UPliPes  (e.g.  water  supply,  sewage  system,  energy  distribuPon  networks,  power  plants,  pipelines,  gas   storage)     •   CommunicaPon  (e.g.  TV/  telephone  transmiNers,  towers,  satellites,  cable  networks)     •   Renewable  energy   Social  infrastructure   •   EducaPon  faciliPes     •   Health  (hospitals  and  health  care  centers)     •   Security  (e.g.  prisons,  police,  military  staPons)     •   Others  (e.g.  parks).   AKUO  INVESTMENT  MANAGEMENT   4  
  5. 5. December 2010Infrastructure  with  a  financial  twist   Akuo  Investment   Financial   industry   analysts   emphasize   the   existence   of   limited   compePPon,   resulPng   from   different   sources.   •   Economic:  natural  monopolies  (e.g.  energy  distribuPon  networks),  public  goods  (e.g.  broadcasPng   •   RegulaPon:  controlled  charges  and  fee  increases  (e.g.  toll  roads),  regulated  uPliPes   •   Concessions  from  public  authoriPes:  long-­‐daPng  contracts  (e.g.  hospitals).   Infrastructure  assets  typically  show  one  or  more  of  the  following  stylized  economic  characterisPcs:   •   High  barriers  to  entry     •   Economies  of  scale  (e.g.  high  fixed,  low  variable  costs)     •   InelasPc  demand  for  services  (giving  pricing  power)     •   Low  operaPng  cost  and  high  target  operaPng  margins     •   Long  duraPon  (e.g.  concessions  of  25  years,  leases  up  to  99  years).   AKUO  INVESTMENT  MANAGEMENT   5  
  6. 6. December 2010Infrastructure  with  a  financial  twist   Akuo  Investment   From   this,   the   investment   industry   deduces   a   number   of   favorable   investment   characterisPcs   of   infrastructure  assets:   •   Stable  and  predictable  cash  flows     •   Long  term  income  streams     •   Oien  inflaPon-­‐linked  (helping  with  liability-­‐matching)     •   In  some  countries,  tax-­‐effecPve     •   Returns  insensiPve  to  the  fluctuaPons  in  business,  interest  rates,  stock  markets     •   RelaPvely  low  default  rates     •   Low  correlaPons  with  other  assets  classes  (offering  diversificaPon  potenPal)     •   Socially  responsible  invesPng  (SRI)  (providing  public  goods  essenPal  to  society)   AKUO  INVESTMENT  MANAGEMENT   6  
  7. 7. December 2010Risks   Akuo  Investment   It  is  an  essenPal  part  of  the  fiduciary  duty  of  those  involved  in  pension  fund  invesPng  to  understand   the  specific  risks  of  infrastructure  assets.  Risks  go  much  further  than  the  usual  volaPlity  staPsPcs,  and   certain  factors  are  just  genuinely  uncertain.   .At  the  level  of  infrastructure  projects  and  companies,  key  risks  include:   •   ConstrucPon  risk  (e.g.  the  project  is  not  completed  on  Pme;  costs  are  higher  than  budgeted…)   •   OperaPonal  risk  (e.g.  poor  management,  systems)   •   Business  risk  (e.g.  more  compePtors  entering;  change  in  consumer  preferences  and  demand;   technological  advances)   •   Gearing  risk  (typical  leverage  of  30-­‐90%,  resulPng  in  a  high  exposure  to  interest  rate  risk;  refinancing   risk  with  higher  inflaPon  and  interest  rates;  downgrade  risk)   •   Legal  and  ownership  risk  (unknown  future  liPgaPon,  planning  consents  not  granted;  lease  running   out…)   •   Regulatory  risk  (e.g.  fee  rises  fall  behind  schedule)     •   Environmental  risk  (unforeseen  environmental  hazards;  acPon  groups)   •   PoliPcal  and  social  risk  (opposiPon  from  pressure  groups;  poliPcians  may  change  their  mind;   corrupPon)   AKUO  INVESTMENT  MANAGEMENT   7  
  8. 8. December 2010Risk  /  return  profiles   Akuo  Investment   Pension   funds   are   presented   all   sorts   of   graphics   with   stylized   risk-­‐return   profiles:   somePmes   showing   infrastructure  with  risk  and  return  both  higher  than  equiPes,  somePmes  both  lower,  and  somePmes  at   higher  returns  and  lower  risk…   When   the   global   infrastructure   boom   started,   return   expectaPons   were   oien   given   as   15%   plus   pa   by   some  providers.   In  their  2005  analysis  of  the  Australian  market,  Mercer  say  that  ―most  managers‘  products  fall  into   the  category  of  diversified  infrastructure  funds  that  have  an  objecPve  to  deliver  returns  of  9  –  12%  net   of  fees.     RREEF   makes   the   disPncPon   between   the   total   return   expectaPons   of   mature   (10   %   –   14%   pa)   and   early-­‐stage   assets   (18%   plus).   It   should   be   noted,   however,   that   such   expectaPons   are   fuelled   by   leveraging   the   returns   of   the   underlying   porYolio.   RREEF   put   a   typical   leverage   rate   of   40–80%   for   mature  and  30–75%  for  early-­‐stage  assets.     The  analysts‘  projecPons  also  vary  across  infrastructure  sectors.  JP  Morgan  Asset  Management,  e.g.,   expects  the  lowest  expected  internal  rates  of  returns  for  toll  roads  (8-­‐2%)  and  PFI/PPP  (9–14%),  and   the   highest   for   airports   (15-­‐18%)   and   broadcast   network   (15-­‐20%),   this   against   an   infrastructure   average  of  10-­‐  15%.   (All  references  available  on  demand)   AKUO  INVESTMENT  MANAGEMENT   8  
  9. 9. December 2010Risk  /  return  profiles   Akuo  Investment   How   do   these   return   expectaPons   compare   to   other   asset   classes?   According   to   a   survey   of   2007,   return  expectaPons  for  the  asset  class  infrastructure  over  10  years  are  an  annualized  9.5%,  pusng  it  in   second   place   behind   private   equity   (11.3%).   In   comparison,   stocks   are   expected   to   return   9.0%,   bonds   5.1%  and  cash  3.7%.  Nowadays,  the  returns  for  cash  namely  would  be  much  lower.   What   is   the   expected   risk   profile   of   infrastructure?   ExpectaPons   for   volaPlity   are   typically   set   somewhere  between  equiPes  and  bonds.  The  asset-­‐liability  model  used  by  Morgan  Stanley  Investment   Management,  e.g.,  compares  five  main  asset  classes.     It  puts  infrastructure  (volaPlity  7.9%,  return  9.3%)  second  only  to  bonds  (4.4%)  in  terms  of  expected   volaPlity  and  second  only  to  private  equity  (10.0%)  in  terms  of  expected  return.   As  an  example  for  pension  funds,  the  Dutch  APG,  expects  a  10%  return  from  infrastructure  with  a  7%   risk.   In   comparison,   the   corresponding   figures   are   6%   /   9%   for   property   and   15%   /   25%   for   private   equity.    CalPERS  are  looking  for  an  annual  return  of  inflaPon  (CPI)  plus  5%  -­‐  7%.   (All  references  available  on  demand)   AKUO  INVESTMENT  MANAGEMENT   9  
  10. 10. December 2010 Akuo  Investment  AKUO  INVESTMENT  MANAGEMENT   10  
  11. 11. December 2010Renewable  Energy   Akuo  Investment   Since  the  first  wind  turbines  were  built  at  the   late  1980s,  power  generaPon  from  wind  energy   has  seen  dynamic  growth.  The  reasons  for  this   unprecedented  boom  in  the  last  15  years  lie  in   the  support  programs  from  naPonal  and  state   governments.  Recent  market  trends  are  in   large-­‐scale  building  operaPons  ranging  from  50   to  several  hundred  MW  of  power  generaPng   capacity.   Sun  energy  is  harvested  through  thermal  solar   plants,  or  photovoltaic  solar  plants  on  rooiops   or  ground-­‐mounts.  Although  development   costs  are  sPll  on  the  high-­‐end,  tariff  policies   have  made  this  area  very  aNracPve.  We  intend   to  focus  on  plants  with  greater  than  1  MWp  of   installed  capacity.   AKUO  INVESTMENT  MANAGEMENT   11  
  12. 12. December 2010Renewable  Energy   Akuo  Investment   Biogas  plants  produce  a  gas  similar  to  natural   gas  and  use  anaerobic  digesPon  processes.  The   adopPon  of  this  waste  processing  technology  is   revoluPonizing  the  agriculture  sector  in  many   countries  and  is  being  used  to  now  produce   both  energy  and  food.  It  is  likely  that  in  the   future,  electricity  generaPon  capacity  will   increase  substanPally.     Biomass  is  mankinds  oldest  source  of  energy.   Market  trends  are  focusing  on  co-­‐generaPon   plants  using  mixed  fuels:  wood,  bagasse,  and   straw  with  up  to  40  MW  of  capacity.   AKUO  INVESTMENT  MANAGEMENT   12  
  13. 13. December 2010Renewable  Energy   Akuo  Investment   We  focus  mainly  on  mini-­‐hydro  projects  with   up  to  50  MW  of  capacity.  Larger  hydro  projects   had  been  the  trend,  but  the  market  is  now   shiiing  to  smaller  units  creaPng  an  aNracPve   niche  market.   Technologies  in  which  Akuo  Investment  does  not  invest  are  omi=ed  here:     ocean  wave  energy,  large  hydro,  CSP…   AKUO  INVESTMENT  MANAGEMENT   13  
  14. 14. December 2010What  is  special  about  renewable  energy?   Akuo  Investment   The  specificiPes  of  renewable  energy  infrastructure  are:   •   Absolutely  No  (or  minimal  for  biomass)  commodity  price  correlaPon:  resources  are  “free”   •   Growing  and  poliPcally  supported  market   •   Socially  welcome  as  sustainable  investments   •   Moderate  size  of  the  projects/investments  per  project  compared  to  other  infrastructure  asset  classes   (airports,  toll  roads…)   •   Asset  class  growing  in  developed  countries  where  tradiPonal  infrastructure  projects  are  less  frequent   •   Electricity  generaPng  assets  are  about  the  future  of  energy  and  the  energy  of  the  future   •   Electricity  cannot  be  stored  on  an  industrial  scale,  has  to  be  consumed   •   Very  liNle  correlaPon  to  business  cycles   •   Feed  in  tariffs  or  PPA’s  (very  long  term  commitments)   •   No  bad  client  risk  (UPliPes  buy  the  energy)   •   Quality  of  the  cash  flows  (banks  accept  generally  much  lower  DSCR’s  then  for  tradiPonally  gas  or  coal   powered  staPons:  1.1-­‐1.2  vs  2.0)  due  to  nature  of  the  availability  of  the  resources   •   Excellent  Pming  due  to  the  pressure  regarding  climate  change  policies   AKUO  INVESTMENT  MANAGEMENT   14  
  15. 15. December 2010Five  essenPal  driving  forces  to  successful  development   Akuo  Investment   AKUO  INVESTMENT  MANAGEMENT   15  
  16. 16. December 2010There  are  misconcepPons  about  renewable  energy   Akuo  Investment  which  need  to  be  cleared  away   As  in  any  new  sector,  several  misconcepPons  circulate  in  the  common  press:   •    Renewable  Energy  is  intrinsically  not  profitable,  and  it  would  never  exist  without  subsidies  (see  the   next  2  slides  in  addendum)   •   Renewable  energy  cannot  replace  any  fossil  fuelled  power  plants,  and  is  just  another  gimmick   •   Renewable  energy  is  for  rich  naPons  only  which  can  afford  subsidies  (Renewable  Energy  has  some  its   greatest  developments  in  emerging  countries  where  the  energy  demand  increase  is  the  highest)   •    Renewable  energy  infrastructure  is  like  cleantech  (Renewable  Energy  Infrastructure  is  to  cleantech   what  programming  languages  are  to  new  web  ventures)   …   AKUO  INVESTMENT  MANAGEMENT   16  
  17. 17. December 2010 Akuo  Investment  For  more  details,  or  a  complete  bibliography  on  this  topic  please  contact  us:  Akuo  Investment  Management   AKUO  INVESTMENT  MANAGEMENT   17  
  18. 18. December 2010Wind  energy  is  compePPve  to  most  other  sources   Akuo  Investment   (All  references  available  on  demand)   AKUO  INVESTMENT  MANAGEMENT   18  
  19. 19. December 2010Solar  energy  is  soon  to  be  compePPve  relaPve  to   Akuo  Investment  nuclear  energy  (US  stats)   (All  references  available  on  demand)   AKUO  INVESTMENT  MANAGEMENT   19