We know what we like

The pension adviser: Theories of relativity

Advisers to pensions such as Cardano must weigh the relative merits of different sub-segments – both within infrastructure and in relation to other investment areas

For Cardano, a UK-based adviser to European pensions, infrastructure is one of a range of “non-traditional” investment areas that can bring diversification to pension funds and help them to meet their funding gaps. Anna Dayn, an investment manager at the firm, says: “Pensions have lots of motivation to invest in infrastructure. It has a long-term horizon and has some very interesting aspects such as current income and inflation protection. Trustees do look at these things.”

 But Dayn is not without reservations. She says:  “There is risk in all types of private equity strategies. Leverage levels in infrastructure are beyond private equity levels, which is important to consider when assessing risk. Inexperienced infrastructure investors brought their infrastructure funds to their knees in the recent past (by misjudging the leverage risk.) Brownfield projects were seen as more stable so they could take on more debt and the banks fell over themselves to provide it. But it went too far.”

Anna Dayn

She is also concerned by demand risk which can be “elastic” depending on the type of asset. For that reason, she prefers the risk profile of utilities compared with transport-related assets. Political risk, meanwhile, is a factor to consider when investing in PPPs, even in the UK. “Government priorities change and you need to have a long-term view of a favourable political environment. That’s uncertain in the UK at the moment.”

One interesting aspect of Cardano’s strategic approach is to compare the risk/return profile of sub-segments within various alternative asset classes to see which are relatively more attractive at any point in time.

As an example of the kind of comparisons she makes, Dayn says: “Brownfield typically yields single digit returns and greenfield is a bit higher. As one compares the risk-reward of infrastructure versus other asset classes, one may conclude that at present infrastructure is not necessarily a better choice than mezzanine or pharmaceutical royalties. If one identifies a strategy that yields higher reward for the same risk, one might choose to abstain from infrastructure.”

Dayn is encouraged by the pricing environment in infrastructure, the edging down of fees and carry charged by fund managers, and the fact that it’s a “ripe time” for spinouts (especially those focusing on specific areas rather than trying to be a “jack of all trades”). She is also looking with interest at infrastructure funds focused on distressed opportunities.

The Newcomer: Selective participation

For the California State Teachers' Retirement System, infrastructure will soon make up a portion of its portfolio, but only select managers will get the $132bn pension’s capital.

It’s odd to call the California State Teachers' Retirement System, one of the longest and most experienced investors in private equity funds, a newcomer to fund investing of any sort.


But that’s precisely the stage it’s at now with infrastructure, having recently appointed its first portfolio manager for the asset class. In February, Diloshini Seneviratne, a senior investment officer on its $16.8 billion private equity portfolio, got the job.

Regardless, the pension already knows what it wants out of infrastructure, says chief investment officer Christopher Ailman.

“These should be very long term assets, somewhat monopolistic so you've got some pricing power relative to inflation,” he says. “So it seems like the kind of asset I should want to buy.”

Why, then, hasn’t CalSTRS been a big player in the market?

“The challenge right now is who's chasing it in the marketplace and you've got to buy things like that on the right terms and with the right management structure,” he says. Clearly, given the struggles of funds like RREEF’s North American Infrastructure Fund, not everyone was able to do so.

Those who were able to deliver, though, will likely have to come to Ailman’s office with a compensation structure different from the private equity industry’s standard 2 percent management fee and 20 percent carried interest fee.

“The private equity 2-and-20 model doesn't work because I want stable cash flows, I don't want to leverage it, I don't want to pay 20 percent because I'm not trying to get this giant return out of it, I'm trying to get something about like a fixed income return,” he says.

CalSTRS fits infrastructure within a larger investment bucked dedicated to inflation-linked investments. It calls the bucket “Absolute Return” and targets a 5 percent allocation. So far, though, the infrastructure portion of the bucket is empty.

Not for long, though.

“We’re going to be doing our first deals,” he says, adding that “at some point we’d like to go direct”. He pointed out that Canadian and Australian pension plans “have been at this for a long, long time” and have their own in-house teams dedicated to direct investing.

“It’d be much easier to partner with them, because they’ve got a pretty big portfolio of high-risk and low-risk stuff,” he said.

“We’re more interested in low-risk stuff,” he added, again indicating the pension’s knowledge of what it wants out of the asset class.

The fund of funds: Transparency and other niggles

Smaller investors in infrastructure funds sometimes feel they are treated unfairly

Lower perceived risk profile, cash yield and an inflation-hedging element – these are the three favourable characteristics of the infrastructure asset class cited most frequently by investors, according to Richard Clarke-Jervoise, a director at Paris-based Quartilium Fund of Funds. However, he adds that some investors are “really looking for” these characteristics while others see them as optional.

Clarke-Jervoise says investors are also concerned by the lack of consensus on fees and carry. While “there is a general feeling that in most cases 2&20 is not applicable, it is unclear whether the right number is 1&10 or something in between. In addition, there are many permutations of both the fee and carry calculation which are much less standard than in private equity. However, while a lot of investors seem to be occupied by the fee issue, he says his own organisation is more worried by “a growing number of inexperienced managers who, in some cases, are not very credible”.

Richard Clarke-Jerevoise

Furthermore, he believes funds are not always good at responding to the needs of smaller investors. “When you’re investing alongside much larger groups your interests may be seen as secondary,” he says. “It can be difficult to get very clear and transparent communication – even on simple things such as team structures and even who owns the management company or the split of carried interest within the management team.”

Clarke-Jervoise believes that the dominance of the larger investors is a by-product of the large amounts of capital being committed as they build out their infrastructure programmes – once this has been achieved, individual fund tickets will not be so large. In the meantime, he believes measures should be taken to protect the interests of smaller investors, such as the appointment of a representative to advisory boards to ensure their voices are heard.

Another problem some investors have with infrastructure is that, for those who cannot typically commit to a fund for longer than 10 or 15 years, the payment of carry is often based on valuations rather than the disposal of assets, given infrastructure’s long hold periods. Clarke-Jervoise says this “introduces a lack of clarity”.

He adds: “Pension funds often want a 5 to 7 percent cash yield, and valuation can be seen as a secondary issue. But, as a fund of funds looking to exit within a 10 to 15 year period, it can have a meaningful effect on our final performance.” [Unlike private equity, it is hard to enforce a carry claw-back since it is linked to valuation rather than cash disposals.]