High valuations in the infrastructure and real estate sectors, which fall under Ontario Teachers’ Pension Plan’s (OTPP) real assets portfolio, have given the pension fund pause for thought, according to the head of its infrastructure group.
“Some of the infrastructure deals completed recently have unsustainably high valuations and are unlikely to deliver appropriate risk-adjusted returns in our opinion,” Andrew Claerhout, head of OTPP’s infrastructure group, told Infrastructure Investor in a recent interview. “A 7 percent IRR may seem attractive versus the returns on a US 30-year sovereign bond which trades at under 3 percent, for example. However, infrastructure is not debt – it’s highly illiquid levered equity.”
This environment has prompted OTPP to stop and reflect before deciding how to respond to the new market conditions. That process, which Claerhout describes as “a journey”, started about 18 months ago – when after having spent 15 years in private equity he was tapped by the institution to head its infrastructure business in September 2013.
“Part of what we did a year ago, is we undertook a strategic review where we looked at what had changed in the infrastructure market in the 15 years we’ve been participating in it; what the current competitive landscape was and what attributes we had as a plan, which includes a large portfolio of assets, a risk-tolerant culture and relatively large team of investment professionals.”
OTPP found that while there were about 10 to 15 global major investors in infrastructure 15 years ago, it could now identify more than 200 competitors. Returns had also changed dramatically, falling from a range of 12 to 16 percent for core infrastructure to single digits that often fell below 8 percent.
In interpreting these findings, “we determined that we needed to be more open-minded in terms of the geographies we were looking at, in terms of the sectors that we were pursuing, in terms of the stage of development of infrastructure that we were getting involved in and in terms of the capability and focus that we bring to the value-creation exercise once we invest in a company,” Claerhout explained.
“Our target for the next several years is to get to C$18 billion (€16.0 billion; $18 billion),” he said, or approximately 11.6 percent of OTPP’s overall portfolio, which at the end of 2014 stood at C$154 billion.
“We’re at C$13 billion currently, so we’re significantly under-allocated,” he said. “We’re not changing that goal but the path that we follow in order to get there may need to be more creative because the market has become more competitive.”
Such creativity, Claerhout explained, involved looking at geographies and sectors it hadn’t considered previously. Traditionally focused on core infrastructure assets in OECD countries, the pension fund has added telecommunications assets, waste disposal projects or even asset-like monopolies such as Camelot Group, which operates the UK National Lottery and which OTPP acquired in July 2010, to its portfolio.
Geographically, the pension fund has added Mexico, Chile, Colombia, Peru, Central Europe and parts of Asia to the list of countries and regions it will consider investing in, in addition to OECD countries.
As for stages of development, OTPP is looking beyond brownfield, particularly in emerging markets where most of the opportunity is around newbuilds.
“For assets that require development expertise and a greater understanding of how engineering, procurement and construction companies work, we’re looking at establishing platforms. The deal we recently did with Santander and PSP Investments is a good example,” he remarked.
In December 2014, OTPP partnered with another major Canadian pension fund, the Public Sector Pension Investment Board (PSP), and Spain’s Banco Santander to jointly acquire a renewable energy and water infrastructure portfolio that until then was solely owned by Santander.
According to a press statement, the assets, which are valued at more than $2 billion, will be transferred to a new company owned equally by all three partners. OTPP, PSP and Santander have all said they intend to invest significant additional amounts of capital in the new company over the next five years.
“That’s investing in an estate of existing renewable energy projects but importantly it’s backing the management team that have a set of capabilities around development, construction and operations to build and manage more infrastructure. So we’re exploring those platforms,” he said.
These platforms are also a way for OTPP to explore “khaki” opportunities, a term Claerhout has coined to describe opportunities mixing brownfield with greenfield.
“What’s stopping us from aggressively pursuing greenfield opportunities through those existing portfolio companies to benefit from the stability, the experience, and the management expertise we have in those companies to do more around development?” Claerhout asked rhetorically.
What the pension fund will not do is “dress up” private equity assets as infrastructure.
“Given how challenging it has been to put money to work, some investors appear to be pursuing opportunities that are so far outside of core infra that they are closer to private equity,” he said.
“So when I talk about new sectors, I’m talking about assets that reside in the cracks between private equity and infrastructure, which with one hand on our hearts we can say ‘this checks enough boxes to be considered infrastructure,’” he concluded.
Based in Toronto, OTPP is an independent organisation that invests the pension fund’s assets and administers the defined benefit pensions of 311,000 active and retired teachers in Ontario.
The pension fund launched its infrastructure strategy in 2001 and invests across a range of infrastructure sub-sectors, including transportation, energy, water and waste.