Search Results for 'inderst'

Risky Business but with Attractive Returns

Ashby Monk

Long time readers of this blog may have been doing a bit of head scratching lately over my sudden predilection to write about infrastructure investments. Well, I think the following headline from this morning’s IPE explains my interest and motivation pretty nicely: “Sovereign wealth funds flock to infrastructure.” In short, SWFs are increasingly keen on this asset class, which means I am too.

Accordingly, I thought I’d offer a quick primer; tell you what sort of returns and risks SWFs are exposing themselves to with infrastructure. In order to make my job easier, however, I’m just going to crib from Georg Inderst. He has a new paper entitled “Infrastructure as an asset class.” It offers a useful framework for understanding all of the considerations of a commercial infrastructure investment.

First, here are the things that separate infrastructure assets from other assets:

  • High barriers to entry;
  • Economies of scale (e.g., high fixed, low variable costs);
  • Inelastic demand for services (giving pricing power);
  • Low operating cost and high target operating margins; and
  • Long duration (e.g., concessions of 25 years, leases of 99 years).

Second, here is the value proposition:

  • Attractive returns;
  • Low sensitivity to swings in the economy and markets;
  • Low correlation of returns with other asset classes;
  • Long-term, stable and predictable cash flows;
  • Good inflation hedge;
  • Low default rates; and
  • Socially responsible investing.

Finally, here are the many risks that need to be managed:

  • Construction risk;
  • Operational and management risk;
  • Business risk (demand, supply factors);
  • Leverage, interest rate risk;
  • Refinancing risk;
  • Legal and ownership risk;
  • Regulatory risk (fees, concessions);
  • Environmental risks;
  • Political and taxation risks; and
  • Social risks (e.g., opposition from pressure groups, corruption);
  • Concentration or cluster risk (small number of similar assets in portfolio);
  • Illiquidity risk (immature secondary market);
  • Pricing risk (valuation basis);
  • Risks related to the governance of investment vehicles (e.g., conflicts of interests, opacity); and
  • Reputation risk.

The risks will undoubtedly vary according to how the fund accesses infrastructure. The risks facing a fund investing through a listed product will be far different than the risks for a direct investor. Anyway, there you have it: SWFs & Infrastructure 101. Class dismissed.

In-Sorcerer: The Magic of Insourcing Infrastructure Investments

Ashby Monk

Helen Thomas of the FT has some bad news for asset managers trying to woo pension assets for their infrastructure funds. She reports that these big funds are bypassing traditional fund managers and investing in infrastructure directly.

“Big pension funds are increasingly looking to invest directly in infrastructure assets…While pension fund managers like infrastructure assets because their extended lifetime helps balance the funds’ long-dated liabilities, they have traditionally relied on investing through third-party funds. However, some of Canada’s largest pension plans, including the CPP Investment Board and Ontario Teachers, have established reputations as canny investors in infrastructure. Now others, including AIMCo and Quebec’s Caisse de Depot, are increasingly using in-house teams to lead their infrastructure investment. Calpers, the largest US pension fund, is also ramping up its efforts…”

For those totally out of the loop, infrastructure assets break down into two broad categories: economic and social. The former typically refers to transport, utilities, or communication investments, while the latter refers to schools, hospitals, prisons or even parks. Generically, pension funds are well suited for these types of investments, as the time horizons and steady cash flows match up nicely with the funds’ long-term pension liabilities. However, pension funds have traditionally (for the most part) relied on asset managers to help them get exposure to this alternative asset class. Not any more apparently.

discussion I recently had with a major pension fund executive on this topic sums up the rationale pretty tightly:

“Why pay all these fund fees if this is an asset we want to hold in our portfolio for the long term?”

Agree to agree. And this is what I had to say in October about this topic and SWFs:

“…a SWF investing in a private asset manager that, in turn, invests in infrastructure just seems off to me. Feel free to disabuse me of this position, but won’t the SWF be giving up its main competitive advantages by doing this (i.e. scale and time horizon)? Again, my view is that the scale and time horizon of SWFs makes them (in theory) world beaters in this specific asset class. Who can bring this amount of money over this time horizon to a single infrastructure project? I’m pretty sure the answer to that question is ‘nobody’. I don’t think…and I could be wrong here…that the private sector asset managers can compete on the same level; the private funds are too small and the duration of the infrastructure assets too long (and the demands of the LPs too myopic).”

I think the same holds true for large, public pension funds. And, apparently, I’m not the only one who has noticed this incoherence. Here’s how George Inderst of the OECD explains the rationale for pensions’ interest in in-sourcing infrastructure:

“Paradoxically, pension funds often find the lifespan of the infrastructure vehicle offered too short for their needs. There is a maturity mismatch between the typical length of private equity-type of funds (typically 10 years) with the liabilities of pension plans (often much longer). Trustees do not like the idea of selling assets that they might have bought for a long-term, steady, inflation-linked income stream. Providers prefer to realize investments and set up successor funds.”

So in-sourcing infrastructure is a good idea, right? Yes. Well, sort of. Actually, plenty can go wrong, so I’ll be the first and the last to say this: in-sourcing has to be done right or not done at all. There are innumerable opportunities to screw up. For more details on the pitfalls, read here.

This means the potential “in-sorcerer” – which I define as any asset owner that seeks to make asset management fees or agency costs magically disappear through a program of in-sourcing (©!) – has to be extremely proactive about organizational design, governance and talent. But, given the right circumstances, that’s totally do-able. All in all, I think this is a positive development. The more money we can profitably direct into infrastructure assets for the long term, the better!


About

This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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