HomeMy WebLinkAboutReports - 2019.07.03 - 32239Introduction to Private Infrastructure
A Primer for Institutional Clients
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Disclosure
This presentation is provided for educational and informational purposes only and should
not be regarded as investment advice or as a recommendation regarding any particular
course of action. This presentation contains forward-looking statements which may be
subject to various uncertainties which could affect the actual outcomes or results from those
indicated.
Past performance is no guarantee of future results.
AndCo Consulting is an investment adviser registered with the U.S. Securities and
Exchange Commission (“SEC”). Registration as an investment adviser does not constitute
an endorsement of the firm by securities regulators nor does it indicate that the adviser has
attained a particular level of skill or ability.
Proprietary and confidential. Not for distribution to the public. Certain information is based
on sources and data believed to be reliable, but their accuracy and completeness cannot be
guaranteed.
The source of all data, charts and graphs is AndCo Consulting unless otherwise stated.
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The Investment Challenge
Expected return from a traditional institutional portfolio will be challenged to
meet return targets
Traditional asset classes (Equities and Fixed Income) tend to be highly
correlated
Equities Fixed Income
U.S. Large Cap 6.41%Core 3.32%
U.S. Mid Cap 6.93%High Yield 5.59%
U.S. Small Cap 7.35%
International 7.61%
Source: Expected return and correlation are from the “2018 JPMorgan Long-Term Capital Market Assumptions”
U.S.
Large Cap
U.S.
Mid Cap
U.S.
Small Cap International Core FI
High
Yield
U.S. Large Cap 1.00
U.S. Mid Cap 0.96 1.00
U.S. Small Cap 0.90 0.95 1.00
International Equities 0.88 0.86 0.76 1.00
Core Fixed Income 0.00 -0.01 -0.10 0.10 1.00
High Yield 0.69 0.74 0.65 0.74 0.19 1.00
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The Investment Challenge
The risk in most traditional institutional portfolios comes from exposure to
economic growth, returns tend to decline significantly around recessions
*60-40 portfolio is comprised of 60% S&P 500 and 40% Bloomberg Barclays U.S. Aggregate Bond, rebalanced quarterly
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-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
1978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200920102011201220132014201520163-year rolling return: 60% Stocks 40% Bonds
Recession 60%-40%
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Addressing the Investment Challenge
Infrastructure assets have characteristics that can address these challenges:
Strong cash flow profile and expected total return
•Relatively steady cash flow through an economic cycle
Lower correlation to other asset classes
Inflation protection
•Some countries contractually link cash flows to inflation measures.
•Overall value of investment should increase with inflation
Less economic sensitivity than public equities
•Essential nature of asset maintains cash flow during downturns
Additionally, long term nature of assets match profile of institutional investor’s liabilities
Ultimately, these benefits improve the risk-return characteristics of a
traditional institutional portfolio, resulting in a more optimal asset allocation
for institutional investors
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Defining Infrastructure
Infrastructure is defined as essential public services and facilities needed for the
general economic operation of a region.
Characteristics include:
Monopolistic or semi-monopolistic position, high barriers to entry
Long useful life
Operate in regulated environments
Stable, relatively predictable cash flows
Lower exposure to business cyclicality
Common types of Infrastructure assets:
Sectors Transportation Energy/Utilities Communications Social
Subsectors
Toll roads/bridges/tunnels
Municipal Parking
Airports
Rail
Mass Transit Networks
Port Facilities
Oil and Gas Pipelines
Regulated Utilities
Renewable Energy
Water
Treatment/Distribution
Communication
Towers
Cable Networks
Satellite Systems
Education Facilities
Healthcare Facilities
Correctional Facilities
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Institutional Investment in Infrastructure
Infrastructure is a global asset class with a majority of the assets in North America,
Western Europe, and Asia/Australia.
•Infrastructure transactions in emerging markets also continue to grow. Oxford
Economics forecasts 48% of annual global infrastructure spending will occur in
Emerging Asia by 2025, up from 30% in 2012.
Infrastructure investing has been popular in Australia for many years within its
superannuation funds. It has also been widely implemented as an asset class in the
public retirement systems of Canada and Western Europe.
•Based on Preqin data, as of March 2017, there was approximately $425 billion of
unlisted infrastructure assets under management compared to $110 billion as of
December 2008.
Acceptance of the asset class among U.S. institutional investors is increasing with
numerous potential opportunities. Investing in U.S. infrastructure assets allows investors
exposure to the asset class without the currency risk exposure.
In 2016, Oxford Economics forecasts total global infrastructure spending from 2015 to
2020 will be in the $26 to $28 trillion range
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Benefits of Implementing an Allocation to Infrastructure
Risk-Adjusted Return Potential
Private global infrastructure is anticipated to generate an attractive long-term, risk-adjusted return profile
relative to equites and fixed income, and a similar profile to core private real estate.
Return
Standard
Deviation
Global Infrastructure*6.89 11.75
U.S. Large Cap 6.41 14.00
U.S. Mid Cap 6.93 16.00
U.S. Small Cap 7.35 18.75
International Equities 7.61 17.25
Core Fixed Income 3.32 3.75
High Yield 5.59 8.50
U.S. Core Real Estate*5.79 10.75
Source: Forecast returns are from the “2018 JPMorgan Long-Term Capital Market Assumptions”
*The JPMorgan assumptions for infrastructure real estate are unlevered returns.
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Benefits of Implementing an Allocation to Infrastructure
Diversification
Private global infrastructure has a low correlation with equities, fixed income, and core private real estate.
Global
Infrastructure
U.S.
Large Cap
U.S.
Mid Cap
U.S.
Small Cap International Core FI
High
Yield
U.S.
Core
RE
Global Infrastructure 1.00
U.S. Large Cap 0.30 1.00
U.S. Mid Cap 0.30 0.96 1.00
U.S. Small Cap 0.28 0.90 0.95 1.00
International Equities 0.26 0.88 0.76 0.76 1.00
Core Fixed Income 0.00 0.00 -0.01 -0.10 0.10 1.00
High Yield 0.22 0.69 0.74 0.65 0.74 0.19 1.00
U.S. Core Real Estate 0.30 0.30 0.31 0.31 0.26 0.31 0.23 1.00
Source: Correlations are derived from the “2018 JPMorgan Long-Term Capital Market Assumptions”
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Implementation Considerations
Infrastructure Strategies
There are three primary types of strategies with varying risk and return profiles that an institution can
utilize to construct an infrastructure portfolio.
Core is a lower-risk strategy, driven primarily by current income
Value-add provides more upside potential than Core, but also adds more risk. It seeks
appreciation while mitigating volatility with some current income generation.
Opportunistic offers the highest risk and highest return potential. It derives most of its return from
appreciation.
Core Value -add Opportunistic
Target Return (net)8% to 10%10% to 12%15% to 17%
Key Risks Operating
Operating
Strategy Execution
Construction
Construction
Strategy Execution
Market, Political
Primary Return Driver Income Appreciation Appreciation
GDP Sensitivity Low High High
Brownfield or Greenfield Brownfield Both Both
Operating Complexity Medium High High
Geography OECD OECD/Non OECD OECD/Non OECD
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Implementation Considerations
Core
Equity investments in operating
assets with established cash
flows and revenue security
from contracts or a regulated
position, situated in developed
markets
Asset types include social
infrastructure, electrical
distribution, water utilities
Value -add
A variety of strategies are
implemented to increase the value
of a core asset, with capital
appreciation usually crystallized in
an exit.
Strategies include: Buy-and-builds,
platform roll-ups, turnarounds are all
relevant examples.
Asset types include midstream oil
and gas, long-haul oil and gas
pipelines, airports, toll roads
Opportunistic
Assets with development risk or
less predicable revenues, such
as uncontracted pipelines,
Asset types include service
companies, some telecom
investments, and greenfield
projects
RiskInfrastructure Strategies
Return
8%15%
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Implementation Considerations
Investment Vehicles
Vehicle type
Minimum
Investment Liquidity Fund Term
Typical
Strategies
Open-end Funds
(private)
$10 million
(negotiable)Quarterly Perpetual Core
Closed-end Funds
(private)
$10 million
(negotiable)Illiquid 10 to 12 years
Core
Value-add
Opportunistic
Debt
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Implementation Considerations
What to consider when selecting the right strategy for your portfolio
Open-end Funds
(private assets)
Closed-end Funds
(private assets)
Key
Advantages
Current income generated
from cash-flowing assets
Low correlation to equity
markets
Direct exposure to
infrastructure assets
Broadest number of
managers and strategies to
select from
Low correlation to public
equity markets
Direct exposure to
infrastructure assets
Key
Disadvantages
Higher fees
Focus on cash-flow, less
upside potential
Leveraged
Less liquid than listed
securities
Higher fees
Leveraged
Blind pool risk
Liquidity is limited to complex
secondary market
transactions
Fit within
Portfolio
Tend to focus on investments
with long-term hold periods
and stable cash flows
Primary component of an
institutional investor’s
infrastructure program
Tend to focus on investments
with a higher risk/return
profile
Complementary component
of an institutional investor’s
infrastructure program
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Implementation Considerations -Risks
Primary considerations to implementing an infrastructure allocation:
Political/Regulatory:
•Regulated Infrastructure assets are subject to changes in government regulations and guarantees.
Governmental regulators typically determine rates that can be charged to customers. Energy
infrastructure, including oil & gas, solar, wind, and nuclear, are particularly vulnerable to this risk.
Asset types:
•For some assets, rate increases are not built into contacts which reduces the extent of inflation
protection. Particularly in US, there is a high reliance on regulators for rate increases, which can be
time-consuming.
Headline:
•High potential for public backlash on rate increases
Currency:
•Exchange rate fluctuations on foreign investments can severely impact returns.
Benchmarking:
•There is no benchmarking standard for private infrastructure strategies. Alternatives include
absolute return, CPI + x%, public benchmark + x%, or comparison to funds of the same vintage
year.
Credit:
•Private funds typically carry 40% to 70% leverage and are sensitive to credit market conditions
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Implementation Considerations -Risks
Primary considerations to implementing an infrastructure allocation:
•Liquidity:
•Open-end private fund’s quarterly liquidity option can lock up depending on withdrawal queue
and market conditions.
UBTI:
Most funds will structure investments to minimize the impact of Unrelated Business Taxable Income
(UBTI). However, certain investments may result in the generation of UBTI. To remedy this,
managers may have offshore blocker vehicle options. Please consult your tax advisor to determine
the impact of UBTI.
ERISA Fiduciary:
Most Private Equity managers are not ERISA fiduciaries by accepting less than 25% of ERISA
commitments or by becoming exempt by registering as a venture capital operating company
(VCOC). If either of these cases, managers will not comply with ERISA standards.
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Implementation Considerations –Manager/Strategy Selection
What does AndCo look for when evaluating Infrastructure managers?
Team stability
•Due to the long-term nature of the investments it is crucial to partner with a team that has had minimal turnover of
key professionals responsible for generating the firm’s track record.
Ability to add value through active management
•Demonstrated capabilities of adding value through techniques such as adding key management personnel,
negotiating contracts, optimizing the capital structure, and pursuing strategic acquisitions.
Strong network for sourcing deal flow
•A long history in the space provides the reputation and relationships needed to generate proprietary deals or greater
participation in limited auctions, which can drive higher returns.
Strong balance sheet for financing
•Most private funds are levered, an ability to access attractive terms on debt will impact total return.
•Valuation Policy
•Valuations are conducted on a quarterly basis. Managers must follow industry standard best practices that are
audited annually by a third party.
Exit strategy
•Closed-end funds have a finite life, managers need to demonstrate a clearly defined exit strategy for the assets.
Track record
•Open-end funds manage redemptions through either cash inflows from new investors or selling assets. Poor
performance can lead to increased redemptions and lack of new inflows. Current investors may be unable to receive
redemption proceeds until assets are sold.
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The Infrastructure Opportunity
AndCo’s View
Allocating 5% to 10% of an institutional portfolio to Infrastructure can make sense, depending on the
investor’s objectives.
We view Infrastructure as a component of a strategic allocation, not a short-term trade idea.
Investors seeking to reduce equity and fixed income risk without sacrificing significant return potential
would benefit from an allocation to infrastructure.
Lower-risk/return strategies with a focus on investments that have stable cash flows and are less
sensitive to economic growth should be the primary component of an infrastructure program.
Higher-risk/return strategies that are dependent on a manager’s operational expertise to create value or
take on development risk can serve as a complementary component of an infrastructure program.
We would avoid listed infrastructure, which does not offer as much diversification or risk reduction as
private infrastructure does.
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Glossary
Brownfield –projects that have existing assets generating cash flow
Capital Call –Occurs when a manager requests a transfer of the portion of the investors’ committed capital. The called capital
is utilized by the manager to make investments and cover expenses.
Carried Interest –performance fee collected by the manager on profits in excess of a predetermined return referred to as a
preferred return
Closed-end Fund –A fund with specified term the manager must liquidate the investments by, generally eight years or longer
Committed Capital –The amount of capital an investor has agreed to invest in a closed-end, private infrastructure fund. The
capital is called on an as needed basis by the manager.
Greenfield –projects that include the construction of new assets
Investment Period or Commitment Period –Refers to the established length of time a manager can call capital for new
investments, generally three to four years
Monopolistic –markets in which a product is controlled by a single producer and there are few, if any, substitutes
Open-end Fund –A perpetual fund with no set end date. New investors buy in at the current Net Asset Value and existing
investors sell at the current Net Asset Value.
Preferred Return –Also referred to as a hurdle rate. The minimum level of return the investment or fund needs to earn before
the manager can earn carried interest.
Vintage Year –The calendar year in which the manager begins investing capital of an infrastructure fund