First State Super: ‘We can’t hide behind our managers’

There are four principles that First State Super’s investment team adhere to, according to infrastructure portfolio manager Mark Hector: putting members first, taking a team approach, excellence, and being bold.

The latter rings particularly true as Infrastructure Investor sits down with Hector, only a week or so after his team won the race for the privatisation of Victoria’s land registry business at a price of A$2.86 billion ($2.02 billion; €1.76 billion).

Almost A$1.3 billion of that represents equity, making it the largest equity cheque First State Super has written for any asset. It’s also the only instance where one of Australia’s major privatisations has gone to a single superannuation fund investing on a direct basis.
It’s fair to say that classifies as bold.

“Being bold is something the investment team is proud of,” Hector says. “We’re not afraid to be a market leader and take the first steps in certain aspects of the market.”

INFRA INCREASE
Mark Hector joined First State Super in 2014 with a remit to beef up the superfund’s in-house investment capability. He previously worked in a variety of infrastructure finance roles in Australia, including for Leighton Contractors and Dutch bank ABN AMRO, as well as a two-year stint in the US with Babcock & Brown.

Richard Brandweiner, First State Super’s chief investment officer at the time, was overseeing an expansion of the pension’s investment team and brought in Hector specifically to head up the infrastructure portfolio.

“We wanted more focus on leveraging off our balance sheet size and doing more direct deals, rather than just investing through fund managers,” Hector says.

First State Super’s assets under management total approximately A$95 billion. Around A$75 billion of that is ‘pure’ First State Super money, a growing pot under FSS’s accumulation superfund model, with the remaining A$20 billion coming from StatePlus, the financial planning arm of New South Wales’ State Super, which it acquired in 2016.

Just under 5 percent of the total combined portfolio is allocated to infrastructure and real assets (the latter including investments in agriculture and water rights). That places First State Super well on its way to the 5 to 6 percent exposure to the asset class Hector is aiming for.

In dollar terms, First State Super has around A$4.5 billion invested in infrastructure and real assets, including the A$1.3 billion of equity that will go into Land Use Victoria, while StatePlus currently has a “few hundred million” invested in the asset class, with an aim to increase this to between A$800 and A$900 million in the coming two years.

“A lot of our focus now is on looking at investments that are suitable to each of First State and StatePlus, and having them both invest together, with common governance,” Hector says.

VICTORIA’S BIG DEAL
One of these recent co-investments is that eye-catching A$2.86 billion deal for 100 percent ownership of the land titles and registry functions of Land Use Victoria on a 40-year concession.

Much has been said and written about land registries’ role in an infrastructure portfolio, but First State Super is a firm believer in the assets’ infrastructure characteristics after being an early mover in the space. It secured a 30 percent stake in New South Wales Land and Property Information, that state’s equivalent to Land Use Victoria, in April 2017, and was also set to participate in the privatisation of the Australian Securities and Investment Commission’s corporate registry, before that process was cancelled in December 2016.

“We felt we owed it to our members to not just invest in traditional asset classes but keep an eye out for some new ones,” Hector says.

“[After the ASIC process] we had an early-mover advantage and we knew that the NSW government was looking to privatise their land registry, so we teamed up with the Hastings [Funds Management] consortium and were lucky enough to win.

“We’ve been operating that for over a year now and we leveraged that operational knowledge going into the Land Use Victoria process – and part of the thesis was not just to be doing one-off deals, but recognising there would be some other land registries, and hopefully down the track some other non-land registry deals, that come to market.”
Victoria was the first of these to come along and Hector acknowledges that the superfund paid a “healthy” price to see off competition from a consortium led by Macquarie Infrastructure and Real Assets and Sunsuper.

“I’m not suggesting we can pick up these assets for bargains – but we’re confident that [the price paid for Victoria’s land registry] represents a good, stable, long-term, appropriate risk-adjusted return for a monopolistic asset class with CPI-linked cashflows, with prudent and innovative debt financing in place on the deal.”

The size of the equity cheque did mean it was “right up against the concentration limits” that First State Super has for individual infrastructure asset investments, but the long-term stability and the need to reach that target SAA meant the investment committee was comfortable with it. Hector also says that both the New South Wales and Victorian governments were “tickled pink” at seeing the businesses go to Australian superfunds, with returns going to Australian workers in the long run.

EMERGING MARKET RISK
Hector describes First State Super’s strategy as a global one, with the split between Australian and offshore investments likely to shift towards overseas transactions in the years to come. It also isn’t afraid to invest in emerging markets if the right opportunity comes along – once again showing a bold streak not often associated with Australian superfunds.

First State Super’s investment guidelines stipulate that the fund can have 40 to 100 percent of its infrastructure and real assets investments in Australia, up to 60 percent in other OECD countries, and up to 20 percent in non-OECD countries.

“That’s quite a healthy potential allocation to emerging markets compared with most of our Australian sister and competing funds. We’ve invested in renewable energy projects in Asia and generated some really solid risk-reward there, and we took advantage of some of the market dislocation in Brazil by teaming up with Brookfield, who’ve been in that market for over 100 years, by buying a big gas pipeline off a distressed seller [Petrobras].

“There are some obvious greater risks going into emerging markets, including the nature of the regulatory and legal framework, and foreign currency exposures – but again, we’re prepared to do our homework and we think that at the right time you can make some good long-term investments there.”

Closer to home, Hector says First State Super is always looking to make “relevant” investments in Australia for its members – those that have a decent risk-reward balance and that satisfy ESG metrics.

“We’re interested in investing in some more greenfield-style investments, including greenfield PPPs. Given the size of the fund, notwithstanding some of the larger PPP deals in Australia, it’s hard to justify the time and effort towards making pure direct investments into greenfield PPPs, so we’ll look to use some partnership arrangements there,” he says.

One such arrangement is Sydney Light Rail, where First State Super is the lead investor in the equity consortium behind the PPP, with a 62.5 percent stake (its partners are John Laing on 32.5 percent and Acciona on 5 percent). That project has proved to be highly controversial in recent months, with cost and programme overruns generating negative headlines.

“As an equity investor, we’re generally wedged in the middle of those challenges between Transport for New South Wales – the client – and our underlying design-and-build contractors – Acciona and Alstom,” Hector says. “Equity still has to play a role in having influence to help resolve it. I think that if you ask anyone within the New South Wales government, they’d be pretty pleased with the way in which we’ve conducted ourselves and tried to come up with pragmatic solutions with the client and contractor to get the project back on track.”

The completion date was pushed back again in October this year to May 2020, around 14 months later than originally planned, with construction costs set to double from initial estimates to A$1.8 billion. Hector adds that the project is “certainly heading in the right direction” now, though, with all three parties working “cohesively” together to get it over the line.

GLOBAL STRATEGY
The problems with Sydney Light Rail do highlight one of the risks that come with doing more direct investing, as First State Super has: potential reputational damage when things go wrong.

“The organisation recognises that by going out on the front foot and making pure direct investments, there are obviously some heightened reputational risks associated with that. But as such a large superfund, we need to show leadership in society and we can’t just hide behind our managers,” Hector says.

Part of the reasoning behind Hector’s appointment in 2014 and the expansion of the investment team was to do exactly that – pursue more direct and semi-direct investments with less participation in pooled funds. Hector defines semi-direct investments as those made with fund managers on investment-management arrangements, or as co-investments with significant governance rights, as well as authority over asset management and divestment decisions.

Hector says this hybrid strategy will continue for the “foreseeable future” and that there is still a place for pooled funds, citing First State Super’s commitment to the $14 billion Brookfield Infrastructure Fund III.

The approach to date has been to focus on pure direct investments in their own backyard – but with opportunities now becoming fewer and far between, attention is slowly beginning to turn overseas, with Hector stating “part of the long-term strategy is to develop some close relationships with some global pension funds, who we’re naturally more aligned to than the fund managers.” Could this lead to First State Super establishing a presence offshore, in the same way that AustralianSuper has recently in London?

“There’s no near-term investment team strategy to be sending people offshore. But I think it’s probably inevitable in the medium term that we may send some investment people to markets offshore to better understand what’s happening on the ground,” he says.

He also acknowledges the challenges in building the investment team, especially in a competitive environment where fund managers can provide higher pay.

“We don’t remunerate like fund managers, so in that sense it’s harder to attract certain types of personalities that are particularly interested in focusing more on finances. But we do offer, generally, a better work-life balance, and some pretty exciting and interesting career opportunities for people to get experience working on direct and semi-direct investments,” he says.

And as long as the hybrid strategy remains in place, there are no immediate plans to materially increase the size of the investment team. “There’s currently no long-term plan to be like some of the Canadians, where they’re totally internalised with pretty large teams,” Hector adds.

With the team now at the size it needs to be, Hector says it plans to take “a bit of a breather” over the next six months or so, after a busy period culminating in the Victoria land registry success. But that doesn’t mean activity in infrastructure will come to a halt, with Hector mentioning one “large offshore investment” that’s close to being finalised – revealed in the weeks following our discussion to be a minority stake in UK-based Forth Ports.

“We still have another A$1 billion to A$2 billion that we’d like to invest in infrastructure and real assets,” he says. “And the fund is naturally growing – we’re at A$95 billion today, but the seven-to-10-year predictions suggest the fund will grow to circa A$160 billion over that time.”

That’s larger than the country’s largest superfund, AustralianSuper, is today.

And with First State Super’s peers also set to grow – and all likely to still be competing for a limited pool of infrastructure assets – the need to be bold will be stronger than ever.