The urge to merge is “overwhelming,” says Troy Rieck, chief investment officer at LGIAsuper. “We’re all trying to be big enough to matter, but small enough to care.”
The trend is growing rapidly among Australian superannuation funds, with underperforming funds under the spotlight from regulators. Infrastructure Investor is speaking to Rieck just six weeks after he started his new role at LGIAsuper, which has its roots as a fund for local government employees in Queensland. The fund, with A$12.79 billion ($8.75 billion; €7.95 billion) under management at 30 June, still draws most of its membership from this pool.
Rieck joined from Melbourne-based Equip Super, where he had an equivalent role as executive officer, investments. Equip recently merged with Catholic Super to create a A$26 billion fund. Other big mergers in the pipeline include tie-ups between Queensland giants QSuper and Sunsuper, which is set to generate a combined entity worth around A$182 billion, and First State Super and VicSuper, which would be worth approximately A$125 billion.
“For the most part it’s very well intentioned,” Rieck says. “Like any industry, you tend to find that these things build momentum and they become a trend, and then everyone’s doing them – and sometimes they look back and say: ‘I don’t really know why.’
“But there will be a much smaller number of funds going forward in Australia.”
The native Queenslander says he was attracted to his new role because it represented a chance to get back to his home state and live again in Brisbane (which he describes as “like a miniature version of Singapore” because of the humidity); and because LGIAsuper is willing to “have a go and do things differently”. He refuses to call it unique, arguing that the word is “dramatically overused”, but says the fund is “a little bit different” in its approach to infrastructure, alternative assets and real estate in particular.
LGIAsuper has done well out of its investments in these asset classes. According to its 2018-19 annual report, it had A$1.13 billion allocated to infrastructure as of 30 June 2019, representing 8.8 percent of its total funds under management. Its allocation to alternatives – under which it brackets debt investments, including a A$165 million commitment to Westbourne Capital’s Yield Fund – stood at A$1.68 billion, representing 13.1 percent of total FUM.
Alternatives returned 4.69 percent for the fund in 2018-19. However, infrastructure was LGIAsuper’s best-performing asset class last year, achieving returns of 12.81 percent thanks to a combination of investments in core infrastructure, what it calls “value-adding” assets and global listed infrastructure.
“There’s another four-letter word that starts with F that we talk about all the time now, and that’s fees”
“We’re big believers in diversification, so we’re trying to find rewarded risks and we’re trying to spread those risks out around the world,” Rieck says. “We’re big believers in the illiquidity premium. We like the stable returns that infrastructure, real estate and other private assets can generate because they help to smooth out the [fund’s overall] return streams over time, and it helps to mitigate some of the large sustained drawdowns you can see in public markets.”
In infrastructure equity, LGIAsuper has made commitments of various sizes to six managers through funds and separately managed accounts. The largest sits with mid-market manager Palisade Investment Partners, where the superfund has allocated A$449 million in a fund that has investments in assets including the North Queensland Gas Pipeline, Regional Livestock Exchanges and Sunshine Coast Airport.
“It’s a wide variety of classic infrastructure businesses and we’re not trying to shoot the lights out with that relationship,” Rieck says. “We’re trying to generate acceptable returns with mid-risk assets.”
The next biggest chunk, outside a A$285 million commitment to listed infrastructure manager Maple-Brown Abbott, is a A$249 million investment with I Squared Capital’s two global infrastructure funds. The superfund’s annual report reveals that the I Squared investment was the star performer within the asset class, delivering a return of 14.58 percent in 2018-19.
LGIAsuper also has smaller commitments, including A$77 million with EQT Infrastructure’s three vehicles, A$12 million in Morgan Stanley’s North Haven Fund I, and A$27 million in the Lighthouse Infrastructure Fund Trust, one of two funds managed by Lighthouse Infrastructure. Rieck says the latter investment sits in the category of “doing well by doing good”, with Lighthouse looking to make investments where there is a “deep social need” in sectors like disability housing, while receiving an acceptable rate of return for the risks involved.
One of LGIAsuper’s most recent investments is with French fund manager Antin Infrastructure Partners, which has made headlines by investing in assets as diverse as crematoriums and food logistics businesses, opening it up to accusations of mandate creep. Yet rigid definitions of what is or is not infrastructure are not of paramount importance to LGIAsuper.
“If you really want to stir up a hornet’s nest here in Australia, ask people what their definitions of growth and defensive assets are, and people will go livid at you. I’ve got a simple answer for that one: I actually don’t care. I only care whether the portfolio is a good one for meeting member outcomes or not.
“These labels are shortcuts, and the problem you have when you take shortcuts is that sometimes you miss nuance. So, we certainly think that infrastructure, real estate and agriculture have both debt and equity characteristics, but they don’t fit naturally into that 100 percent growth or 100 percent defensive categorisation. We talk about them as mid-risk assets, so we’d need three or four categorisations – or my preference would be to throw those categorisations away altogether.”
He says Antin is a good example of this. Although some of its investments don’t fit a classic definition of infrastructure, they do have “certainty of supply and cashflows”.
Thought for food
Rieck also mentions the superfund’s investment with US-based Equilibrium Capital’s Controlled Environment Foods Fund. This looks at first glance like an agriculture investment, but it has a lot in common with infrastructure as well. “They’re essentially taking infrastructure skills and applying that to food production to build greenhouses. The plan here is to either construct or purchase greenhouses and then sign take-or-pay contracts with the large retailers in the US. That’s about delivering certainty of high-quality supply and doing it in a way that’s acceptable to institutional investors.”
Rieck says LGIAsuper is still underweight in infrastructure and is aiming to increase its allocation to 10 percent of its total funds under management. That means another couple of hundred million dollars could be deployed in the asset class soon. “The real challenge we’re all trying to wrestle with is the low returns we’re getting from the defensive parts of the portfolio. Cash and bond returns are sub-1 percent.
“A lot of our membership tends to have a higher-than-average balance compared to others in the industry, and they’re relatively conservative, so that low return from defensive assets is a huge challenge. One of the big things that sits on my radar here for the next three years is increasing the amount of sustainable-yield generation in the portfolio.”
Credit strategies could form a vital part of this, building on the fund’s existing commitment to Westbourne Capital, which Rieck describes as a “really solid infrastructure debt manager, experienced and conservative”.
“Debt fits very much in this mid-risk asset approach that we’ve taken historically, so it’s going to be useful for our pension members and it forms a core base for the accumulation and the defined benefit options as well. We have a strategic allocation review coming up in the first half of next year and we’ll need to do some hard thinking. You may be able to express some of these ideas around infrastructure, real estate and agriculture through private debt as successfully as you can through private equity.”
In addition, Rieck says an increase in co-investments is worthy of consideration as the fund continues to grow. “Co-investments aren’t straightforward. You do take additional risk. But if you’ve hired the right operators in the first place and you understand the risks, you can certainly get a better overall fee deal by making material co-investments alongside your fund investments.”
This brings Rieck neatly to another consideration for LGIAsuper, and for most other Australian superfunds we have spoken to.
“If you’ve spoken to Australians previously, you’ll know that we like four-letter words that start with F. And there’s another four-letter word that starts with F that we talk about all the time now, and that’s fees.
“I’ve got no problems paying for genuine value-add. But when we go into a relationship here, we want to understand the economics of the deal. We look for alignment between ourselves and the manager. We want to know about the fee structure and you’re always looking for people with deep experience in the industry who’ve got an edge and who have built a process to exploit it.”
However, he says it is “a fact of life” that pressure over fees is making things increasingly challenging for superfunds, and that this is a practical constraint on what they can do. It is also bound up in Australian regulators’ increasing focus on funds’ performance, which is leading to that “urge to merge”.
“[As a sector], we want the scale benefits that come with being larger, but we don’t want to lose focus on our memberships. It does change the investment strategy for a fund when you get to be really large.
“I think we’re big enough to matter and small enough to care. We’re not trying to be the solution for every person in Australia – we’re trying to be the best solution for the local government employees of Queensland.
“And that makes my socks roll up and down, quite frankly. I’m very pleased to be a small part of that.”