It’s hard not to think about hydrocarbons in the Lone Star State, especially when sitting in the Teacher Retirement System of Texas’s offices in downtown Austin, an up -and-coming US city that sits between the gushing Permian shale basin to the west and the ports sprouting up along the coast of the Gulf of Mexico near Houston to the east.
But thinking less about energy is exactly what the $154 billion pension fund – the state’s largest – wants to do. “We need a diversified portfolio,” Carolyn Hansard, senior director of TRS’s energy, natural resources and infrastructure portfolio, tells Infrastructure Investor.
The ENRI portfolio she manages consists of profitable but volatile upstream oil and natural gas investments balanced by infrastructure assets backed by long-term contracts. The catch is that the majority of TRS’s infrastructure portfolio consists of midstream assets, pipelines and storage terminals that service the energy sector. This has created a balancing act for Hansard and the team.
“Generally speaking, the energy portfolio is more commodity-sensitive,” she explains. “So it’s going to be more volatile, though energy will obviously provide a big uplift during inflation. The infrastructure part provides some stability to that volatility.”
Hansard says TRS gravitated towards the North American energy sector because it is mostly privatised and that is where the capital needs have been.
The US has experienced a renaissance in its energy industry this decade thanks to drilling advances in shale oil and gas fields. Oil production is at an all-time high of 12 million barrels per day, according to the US Energy Information Administration, which predicts natural gas production will reach 90.2 billion cubic feet per day this year.
Hansard made clear that TRS’s intent is not to turn its attention away from the energy sector entirely. The goal is to even out the $7.9 billion ENRI portfolio, of which approximately 55 percent of the capital is invested in energy and 38 percent in infrastructure, a large portion of the latter being midstream.
“I wouldn’t say we’re dialing back,” Hansard explains. “But because we’re overweight in energy, we have to have really high conviction around opportunities in that space, so the portfolio doesn’t become even more overweight.” New opportunities in infrastructure are emerging that make a strong case for diversifying as well, Hansard says.
After TRS hosted a conference in February, alongside the Employees Retirement System of Texas, which saw 1,600 emerging managers visit Austin to vie for commitments from the two pensions, Hansard says the ENRI team now has a full pipeline of deals that “don’t fit into the energy space”.
That may be good news for a limited partner looking to diversify, but Hansard says she will be critical of how those options are presented. Instead of echoing ‘classic’ industry worries about a healthy economy or a wall of capital flooding the market, Hansard’s biggest concern today is “people that say they’re doing infrastructure and really aren’t”.
“In changing times, the definition of infrastructure probably does need to be expanded,” she concedes. “But my concern is that some managers take just one part of the definition – like certainty of cashflows – as opposed to the totality of things that we think make infrastructure separate from other asset classes.”
How Hansard and her team maintain discipline as they plot the growth of their infrastructure portfolio is where the challenge lies, of course.
In 2013, Hansard joined TRS in a homecoming for the Texas native after an 18-year career with investment bank Merrill Lynch in New York and London. Hansard’s small hometown of Lake Jackson is only about a three-hour drive from Austin. The stadium where she watched her school, the University of Texas at Austin, play football on Saturdays is a short walk away.
She came to TRS five years into the pension building out its infrastructure portfolio as part of a real-assets group alongside real estate. In 2017, TRS combined energy and infrastructure and set a target allocation of 5 percent of the pension’s total fund, split evenly between the two sectors at 45 percent each, according to published documents. Agriculture received a 10 percent target.
Hansard does not comment on specific returns for the ENRI portfolio beyond saying “infrastructure has pretty much [performed] in line with the rest of the asset class”. However, she pointed out that TRS uses the Cambridge Associates Infrastructure and Natural Resources benchmark indices and that the pension’s overall return target is 7.25 percent.
Her tenure at Merrill Lynch included working as a financial analyst, chief financial officer of an international equities group and helping to launch a global derivatives business and two electronic trading platforms.
More than anything, Hansard says working at Merrill Lynch taught her discipline: “We’re very disciplined about making investments that truly have [infrastructure] characteristics.” For TRS, that means protection against inflation, high barriers to entry and assets with long-term contracts that have downside protection: “If it doesn’t meet those criteria, we typically don’t do it.”
As she looks to diversify TRS’s portfolio, Hansard says she is staying in tune with how the world is changing. As a long-term infrastructure investor, Hansard says she specifically looks for “changes in the way we live”.
In 2019, that means the telecoms sector tops the list. Broadband towers, data centres and fibre cables have risen in prominence among investors in recent years as high-speed internet connects the world and economies move to cloud-based data management.
“Across the spectrum, telecoms are big on our list,” Hansard says. “You don’t go anywhere today and not expect to have wi-fi and high-speed internet. It’s just part of the way we live, and it’s an area that has a lot of growth [potential].”
Another thing she watches out for is changes in the way others live. Emerging markets need infrastructure investments, and the risk profile of those projects is shrinking, Hansard explains. At the same time, competition for assets in developed countries is at an all-time high.
“Emerging markets are an area we’re going to be focused on to see what the opportunities are,” Hansard says, noting that TRS will continue to be cautious about those investments. “Counterparty risk is much higher, so you’ve got to figure out how to mitigate that risk with a creditworthy counterparty.”
TRS has a growing interest in Asia, Hansard says, noting that the ENRI portfolio has gained limited exposure to the region through commitments to KKR’s fund strategies. Right now, Hansard says her team is assessing whether the pension should increase its exposure. “That’s a huge part of the world and every geography is different. That is a market that we’re still doing diligence on.”
The other leg of Hansard’s expansion strategy is to choose partnerships wisely: “Every manager is in our portfolio for a reason. We target their area of expertise.”
In that sense, a $200 million commitment to Digital Colony Partners’ $4 billion-plus debut fund puts the pension in line to capitalise on the digital infrastructure revolution. A $200 million commitment to Actis Energy 4 also gives it exposure to power investments in emerging markets.
Tellingly, though, one of the recent infrastructure deals that got Hansard particularly excited was in the midstream space, unwittingly illustrating how hard it might be to break old habits. In January, TRS joined Blackstone in a $3.3 billion deal to purchase a 44 percent stake in Kansas-based midstream company Tallgrass Energy. Despite the ENRI portfolio being overexposed to energy, Hansard says: “It is very hard to get pipeline in the ground. Those are really valuable assets, so we’re actually very excited about that deal.”
Another reason for her excitement is the way TRS structured the deal as a co-investment. The pension is planning to make co-investments a larger part of its strategy, as “a way for us to add alpha to the portfolio”. She plans for the ENRI group to increase the amount of co-investment deals from 30 to 40 percent in the coming years. “TRS has always had co-investments as a priority, and it’s a growing priority.”
The $250 million commitment TRS made to Blackstone’s infrastructure fund, which seeks to raise $40 billion over the next decade, gives it access to “mega-deals” like Tallgrass Energy and to an open-ended fund structure. “We have a manager who knows telecoms, one who really knows power. There is some overlap, but we try not to invest with managers that are always going to be competing against each other.”
TRS may pick managers with distinct strategies, but Hansard says she still impresses on them the need to stick to the script they sell. Introducing assets TRS was not counting on to a carefully structured portfolio could upset the balance.“If you tell us this is what you do, you have to be disciplined about that,” she says. “We want to make sure you do what you say you’re going to do and have a process to maintain it.”
“We have seen some opportunities that leave us asking, ‘How exactly is this infrastructure?’ Do not be afraid to say, ‘Let’s walk through this again’.” Hansard
The ENRI portfolio at TRS is likely to look different in the coming years from what it does today. The direction the pension will take is set to be codified in September as part of a five-year strategic asset allocation review. “It could be that everything is working great, so carry on,” Hansard says. “Or it could be that we change direction. We just started the process.”
She is clear, though, that an ENRI portfolio overweight on energy is in need of change. That kind of tilted exposure leaves TRS one commodity price shock away from managing a portfolio with a vastly different performance. The timing for a change is in TRS’s favour, and there are plenty of new infrastructure opportunities to choose from.
As Hansard leads this reorientation, she says the number one lesson learned from her career in finance will be key: “Never be afraid to say, ‘I don’t understand, explain that to me’. We have seen some opportunities that leave us asking, ‘How exactly is this infrastructure?’ Do not be afraid to say, ‘Let’s walk through this again’.”