Investment in large-scale infrastructure such as ports, roads and rail is a natural fit for non-profit retirement funds in search of steady returns, writes Barbara Drury.
As Jane Austen might say, a superannuation system in possession of a $1.4 trillion fortune and under pressure to reduce exposure to shares must be in want of alternatives. State and federal governments have ready-made investments but a shortage of funds to build the new roads, rail, ports and other big infrastructure projects the nation needs.
It's a marriage made in heaven, and the symmetry is not lost on either party. The federal government's infrastructure adviser recently highlighted up to $219 billion of "lazy" state government assets that could be sold to private investors such as large super funds, freeing up cash for new projects and boosting productivity.
"There is a lot of capital waiting to invest in government infrastructure, but there is a preference for brownfield [existing] assets," the head of Australian infrastructure at AMP Capital, Paul Foster, says. This would allow governments to reinvest in new infrastructure, which could be sold later, he adds.
Foster says super funds are less interested in investing in greenfields (new) projects such as the next generation of toll roads, but at least one super fund is bucking the trend (see box, far right).
According to a report from Infrastructure Australia, many existing assets could be sold fairly quickly without regulatory changes. It singled out Snowy Hydro; the three NSW energy distributors, Ausgrid, Essential Energy and Endeavour Energy; Sydney Water; and ports in Newcastle, Western Australia, Gladstone and Tasmania.
In return, says the national infrastructure co-ordinator, Michael Deegan, super funds would end up with good-quality assets that would help diversify their equity risk, and their members would get a good return on savings and be part of nation-building.
The funds management group, Industry Funds Management (IFM), has been pushing for the industry to play a bigger role in nation-building for some time. It is Australia's largest infrastructure investor, with about $11 billion in assets, including ports (both sea and air), renewable energy, toll roads, electricity generation and social infrastructure. The chief executive of IFM, Brett Himbury, says there is an increasing appetite for super funds to look at opportunities in unlisted asset classes such as infrastructure, private equity and unlisted debt markets.
"Equity returns have been disappointing and the global outlook for the next few years is uncertain. Infrastructure presents a relatively attractive opportunity in an uncertain environment," Himbury says.
The privatisation of public infrastructure assets has been politically difficult until now, especially for state Labor governments. Deegan is hopeful that progress can be made by linking privatisation to the benefits of nation-building and improved productivity from ageing assets.
For example, the Queensland government has earmarked the proceeds from its recent sale of the Port of Brisbane for investment in new assets, and the NSW government has said part of the money raised from any future sale of Port Botany and Port Kembla would be made available to finish the Pacific Highway upgrade.
"We think that's the smart way to go about this to keep the community onside," Deegan says. "The community wants governments to build more infrastructure and they want reassurance about the timeline."
Infrastructure provides diversification in an investment portfolio because it behaves differently to mainstream assets such as shares.
Foster says infrastructure assets provide predictable revenue with low volatility compared with a traditional listed company that mines iron ore: "Irrespective of whether the economy is booming or depressed, people still need electricity."
Foster says underinvestment in infrastructure is a global phenomenon, with the debate centred on whether new infrastructure or more investment in existing assets is needed to boost productivity. AMP Capital has $6.7 billion invested in infrastructure globally, with strict investment criteria. Assets must provide an essential service with a long lifespan and have significant barriers to entry so competition is limited. They must be simple to operate once built and offer a long-term contract with a government or other entity that has a low risk of payment default.
"We look for investments with inflation-linked pricing," Foster says. "Infrastructure is a reliable generator of after-inflation returns." In the case of toll roads, most operators can increase tolls with inflation to preserve cash flows.
As well as traditional assets such as roads, ports, utilities and water-treatment plants, AMP invests in social infrastructure such as schools and hospitals through private-public partnerships with governments. It owns the physical assets of eight schools in South Australia, which it leases back to the state government. After 35 years, the schools will be handed back to the state. The IFM's Australian infrastructure fund has been going for 17 years, with the objective of providing average returns of 10 per cent a year after fees and tax, but actual returns have averaged 12 per cent a year net of fees and tax. Himbury says the fund was established to provide higher certainty and less volatility than equities, albeit with lower returns, but it has actually performed better than equities.
"I'm confident our 10 per cent objective is achievable going forward, but there are a lot more people wanting to buy infrastructure assets, so returns may come down [from previous levels]," he says. Like AMP, IFM prefers to minimise risk by investing in existing infrastructure, such as the Port of Brisbane, where there is already a history of returns. This is one reason the prospect of buying existing assets from cash-strapped state governments so they can invest in new infrastructure is so appealing.
"Let [government] take the risk of building new tollways," Himbury says.
Foster agrees. "Most super funds don't want to put aside capital in a greenfields site for three or four years while it is commissioned," he says. "We prefer operating assets where the performance and risks are understood and, most importantly, generating earnings from day one."
The research manager of SuperRatings, Kirby Rappell, says there is a long-term trend for super funds to allocate money to alternative investments. The non-profit sector (corporate, public and industry super funds) has an average of 17 per cent of funds under management in alternatives, mostly infrastructure, compared with 4.5 per cent for master trusts (or retail funds), which prefer listed alternatives such as hedge funds.
Non-profits also have more in property than retail funds (10.6 compared with 7.3 per cent) but less in bonds and fixed interest (16.2 per cent compared with 20.2 per cent). In some ways, infrastructure behaves like a long-term bond with a predictable income stream.
"Super investors are looking for reasonable returns - that is, inflation plus 3 to 6 per cent - with a high level of risk management. Super is a long-term liability, so you need assets that reflect that," Himbury says.
Investors' savings may be locked up in super for up to 40 years. Infrastructure assets have the potential to produce reliable income streams for even longer, often backed by a government contract. Many such projects come with 99-year leases. "That's a long time to have ownership of a productive business," Foster says.
For example, IFM was part of the consortium awarded a 99-year lease for the Port of Brisbane. The initial $2.1 billion outlay will provide income for generations of super members.
The Chant West research manager, Mano Mohankumar, says unlisted infrastructure is a good fit for large industry and public sector super funds, as their membership bases are more stable and net cash flows strong.
A 2008 Chant West study found industry funds, which enjoy the lion's share of compulsory employer contributions, had positive net cash flows of 9 per cent compared with 5 per cent for retail funds.
Super fund not resting on its laurels
REST Industry Super is taking the road less travelled with its infrastructure investments: by pursuing toll-road projects with the Spanish infrastructure developer Cintra.
"We'll be involved from the developmental stage of the deal," says the chief executive of REST, Damian Hill. "This could be for greenfield or existing toll roads."
Despite high-profile disasters such as Sydney's Cross City Tunnel, Hill says Australia has an urgent need for roads. By teaming up with a proven operator, the fund hopes
to mitigate risks such as overestimating patronage or underestimating construction costs.
REST's default fund was the top performer over the decade to June 30, according to research group Rainmaker, a result Hill says was helped by its infrastructure investments during the GFC turmoil.
REST has invested in infrastructure since the mid-1990s, directly and through external fund managers. Its asset holdings include the M5 Motorway, Melbourne Airport and the Cape Otway to Adelaide sea gas pipeline, and it built Western Australia's Collgar Wind Farm.
REST has about 5 per cent of its funds in infrastructure; Hill says this could be doubled with the right deals.
"We are long-term investors with a young [member] demographic, so the reliable income streams from infrastructure investments over a long period of time fits us well," he says. "Infrastructure, property and other alternative assets help us diversify our equity exposure."