Mr Versatility

ISN’T PGGM, THE Dutch pension fund administrator, best known – together with larger Dutch pension asset manager APG – for its direct approach to infrastructure investing? That may be true. But if you also referred to it as a general partner (GP), you certainly wouldn’t be wrong. After all, it’s as a GP that PGGM, which manages over €105 billion from five pension fund clients in the care and welfare sectors, is presently investing in infrastructure.

“We currently invest [in infrastructure] through the PGGM Infrastructure Fund, which is a fund we started in January 2010,” states Henk Huizing, PGGM’s head of infrastructure investments, matter-offactly.

“Our three pension clients that invest in infrastructure provided commitments of €1.25 billion into this fund,” he adds.

“Until 2010, we just had a segregated portfolio for PFZW [PGGM’s largest client with €102 billion of assets under management], but from 2010 onwards we have this infrastructure fund, which has a two-year investment period. We are currently one-and-a-half years down the road and we have presently invested €1 billion, so we are almost there.”

But is this vehicle really structured as an infrastructure fund, I venture to ask, with a standard fee structure? “We have signed a separate agreement with each client and a performance fee may be part of this agreement. If there is a performance fee, it is on a total portfolio level, not on a separate fund level,” Huizing explains.

And if this first fund is almost fully invested…“Our current PGGM Infrastructure Fund, which is targeting a yield of 5 percent, has a two-year investment period, ending December 2011. We plan to start a new fund at the beginning of 2012,” Huizing cuts in, anticipating the question.

The way PGGM’s pension clients approach their allocation to infrastructure has strong similarities with the traditional relationship between limited partners (LPs) and GPs:

“If we talk about [infrastructure] allocations, currently we have assets under management/invested capital of €1.6 billion. And if we add commitments to infrastructure then it’s €2.5 billion. So for PFZW it means a 1.6 percent actual allocation to infrastructure, which is still very modest, certainly compared with the Canadian and Australian pension funds – sometimes they have allocations to infrastructure of 10 percent or 15 percent,” Huizing says.

“I don’t know if we’ll get there,” he muses. “But there is a growth target [for our infrastructure allocation] – I think it’s 2.5 percent to 3 percent within the next two-and-a-half years. Of course, further growth in the allocation will depend on our performance. So if we perform well, it’s likely that our allocation will increase,” Huizing adds. Sounds like something many GPs have probably heard before, doesn’t it?

DEVELOPER PARTNERSHIPS

While this structure may seem unusual at first glance, it’s actually quite logical once one examines the recent history of the Netherlands’ largest pension funds. Toward the end of 2006, PGGM (which at the time was the pension fund now known as PFZW) decided to separate its policy arm from its asset management division. The change was implemented in 2008, in response to Dutch legislation which would have limited PGGM’s ability to provide certain financial services.

Thus PFZW was born, with PGGM rebranded as its asset management arm (although PGGM has since taken on board other clients). Much the same has happened with APG, the asset management subsidiary which spun out of ABP, the Netherlands’largest pension fund. PFZW is the country’s second-largest pension.

So once you regard PGGM as an asset manager, the idea of it setting up an infrastructure fund to carry out an investment policy doesn’t sound so strange anymore. It also helps shed considerable light on PGGM’s much publicised, recent joint ventures (JVs) with two industry developers: Australia’s Lend Lease and the Netherlands’ BAM PPP.

At the time of their announcement, Huizing repeatedly referred to these structures as examples of PGGM’s new direct investment policy. But while it was obvious that PGGM would certainly acquire direct ownership of the majority of the assets it acquired as part of these JVs, it was less clear if it would be involved in their day-to-day operations.

It was also unclear if these structures, one of them known as the Lend Lease UK Infrastructure Fund, would involve PGGM paying fees to the developers. And if fees are being paid, then what makes these partnerships so different from investing in a traditional infrastructure fund?

“Let’s take the example of a typical GP structure, with a management fee of anything between 1.25 percent and 2 percent and a performance fee of 20 over 8 percent with a catch-up. [Compared with this], these [developer] structures are completely different,” Huizing argues.

“We pay fees, it’s no secret, but we pay a management fee which is cost-based. I think you can view it in this way: either we would have to put in our own people [managing the daily operations] or we would have to hire somebody else to do that for us. And in this case, Lend Lease is doing it for us – or for the JV, in fact,” he clarifies, using Lend Lease as an example.

“So, we pay a slight, cost-based management fee, based on actual activities, and we pay an outperformance fee. That’s also a difference: there’s no catch-up whatsoever; there’s a hurdle rate and a slight outperformance fee just to incentivise Lend Lease to get the best out of the projects,” Huizing concludes.

With the developers taking care of the daily management of their jointly held assets, PGGM exerts its influence on a governance level. “In both JVs, there is a board with four seats and both Lend Lease and BAM have two board seats and we [PGGM] have two board seats. So all the important decisions are made on an equal basis,” Huizing explains, adding: “In fact, we have a veto right.”

While these JVs got enormous publicity on the back of their ‘innovative’ structures, they are not the first time a developer has teamed up with an institutional investor. A well-known developer established a similar, albeit less publicised JV, a few years ago with an insurance company, only to have the arrangement collapse two or three years after it was launched due to an apparent misalignment of interests.

Huizing seems surprised to hear about this. “Both JVs are still very young so they are not at the critical stage of three to seven years.

But actually, the JVs are planned for a period of 25 to 30 years and we believe the other parties will be there for the very long term, because Lend Lease and BAM are managing the assets – they are not just shareholders in the JVs – which is very important for them. So there’s a strong alignment between all parties involved, with a long-term view,” Huizing says.

He adds, brow furrowed: “It’s also a matter of reputation. There’s been a lot of attention in the press to both JVs, so if things go wrong in two or three years it would not be good – either for us or for them. I think reputation is also critical here.”

RISKY REGULATION

Since the public-private partnerships (PPPs) owned by these JVs are mostly backed by government availability payments – public contributions paid over a long period of time in exchange for making the assets available in good condition – are these the type of assets PGGM prefers?

“We have a very black-and-white scenario when it comes to infrastructure: either it’s core or non-core. Non-core has more volume or price risk, or more GDP [gross domestic product] linkage. Everything that doesn’t have that, we broadly consider to be core infrastructure (including regulated assets and PPPs). 

Core infrastructure is the focus of our portfolio and we prefer that about two-thirds of it fall into the core category, in the broader sense,” Huizing answers.

But don’t expect to see PGGM as part of an institutional investor consortium similar to the one that recently bought German power transmission operator Amprion from utility RWE.

“Let me first explain that regulatory risk has proven to be the biggest risk in infrastructure over the last two years and that’s a relatively new experience for us, because it has evolved over time, and we have seen some dramatic examples over the last two to three years of what regulation can do. We have become very cautious about regulatory risk and have decided not to engage in deals that involve substantial regulatory risk,” Huizing comments, before frankly admitting:

“We were involved in Spanish solar, through funds, so we took a hit last year. Also, in Italy there was something going on with the [solar] regulation that will have a negative impact for the future, so regulation is an issue.

We know that some PPPs in Spain are paid by the regions and that these regions have very high debt positions – so that’s another thing to bear in mind and be cautious about,” he adds.

Considering it’s the first time I’ve heard Huizing mention PGGM’s investment in third-party infrastructure funds, I take the opportunity to ask him what he dislikes about traditional infrastructure funds and under which circumstances he invests in them.

“When we started investing in infrastructure in 2005, we started investing through traditional funds, which made sense because we began with a very small team. With a small team, there’s just one way to invest, which is through a fund. So there will always be infrastructure funds,” he says.

‘FUNDS NEUTER LONG-TERM CASH FLOWS’

“Our problem with [traditional funds] concerns governance, fee structures, but maybe the most important consideration is that the typical infrastructure asset has a life of 25 to 30 years and infrastructure funds have a life-span of, probably, 10 years. They start with an investment period of five years and then they have a sort of asset management cycle for five years and then they have to exit,” Huizing argues.

According to Huizing, that life cycle neutralises what institutional investors appreciate about infrastructure.

“What pension funds like about infrastructure is the long-term stable cash flows of these assets. If you invest through a fund, there’s no yield in the first two or three years because they are still in the build-up phase. Then you have a period of three to four years where you have a sort of stable cash flow
– but it’s certainly not 9 percent or 10 percent yield, it’s more like 3 percent or 4 percent,” he
explains.

Huizing continues: “Then there’s this huge exit return, which means there’s certainly not a long-term, stable cash flow. Plus, your total return is dependent on your exit return, which is dependent on the conditions at the time a fund exits. So if you invest in infrastructure through a fund, you don’t get
access to the really nice characteristics which this asset class can offer a pension fund. What
we try to achieve is 25 to 30 years of very stable cash flows.”

Does that mean Huizing subscribes to the school of yield over returns, which has led many GPs to derisively state that it’s easy to get yield as long as you squeeze an asset?

“I think we have a balanced position,” Huizing says. “On the one hand, yield is important because we want to show our clients their investments are successful – and the evidence is better with yield than with
valuation return. On the other hand, we and our clients have a very long-term view, so if we would ‘squeeze’ the assets at the cost of long-term return we would not be acting in the best interests of our clients,” he says, concluding:

“In our fund, we really try to achieve balance – it’s not like we give priority to yield over returns, more the other way around actually.” For the record, PGGM is targeting average returns of 10 percent from its infrastructure portfolio.

These days PGGM will still use infrastructure funds, but only in certain contexts. “We haven’t focused on funds anymore over the last three years, with a few exceptions, such as emerging markets, where it’s always difficult to invest directly,” Huizing says. “So in places like China or India, we would prefer funds and we have actually used them. But for the rest we prefer direct investments,” he adds.

Huizing doesn’t hide his interest in these promising emerging markets. “Asia interests us – in the short term, China and India, and, in the longer term, probably Vietnam, Thailand and Indonesia. Latin America also interests us. Our current portfolio is less than 5 percent exposed to emerging markets. But our target is to invest 25 percent in emerging markets in five years’ time, so there is a strong growth target there,” Huizing says.

GPs looking to get a slice of PGGM’s €105 billion-plus cash pile would do well to take note.