$500m worth of good faith

In announcing its February investment in Industry Funds Management – the largest-ever single allocation to an infrastructure fund by a North American limited partner (LP) – the California State Teachers’ Retirement System (CalSTRS) dropped a delicate hint about its approach to a space it still considers fledgling: restraint is in order.

“CalSTRS is relatively new to the sector and we want to get to know it well before we venture beyond the fund structure,” says Christopher Ailman, the organisation’s chief investment officer.

It was a shrewd caveat. Without substantial prior experience within the asset class, CalSTRS made a $500 million commitment to infrastructure via an allocation to Australian-based fund manager Industry Funds Management (IFM). Far from jumping in with both feet, CalSTRS, the $145 billion pension fund with a membership topping 856,000, made clear its preference for dipping its toe in the water—and there’s good reason for that.

Sidelined by the global financial crisis, pent-up pension fund capital is set to come into the asset class in a big way. As far as CalSTRS is concerned, infrastructure has “promise” – especially with respect to portfolio diversification.

“What the economic crisis demonstrated was the need for greater diversification in our portfolio,” explains CalSTRS’ investment committee chairman Harry Keiley.

Keiley, a high school teacher from Santa Monica, California, went on in a statement to cite a need for “a hedge against inflation,” signaling a deepening recognition that infrastructure can fall into the inflation-hedging bucket in a pension fund’s portfolio. 

CalSTRS is no stranger to looking elsewhere than traditional equity and fixed income. In the previous decade, the pension fund came to recognise the value of having an alternative asset programme. In 2005 and 2006, it recorded a respective 32 percent and 27 percent return from its alternative basket, which outperformed its general portfolio in 2006 with a vast collection of private equity fund interests (“We played it smart,” Ailman said).

In 2008, CalSTRS decided to move into infrastructure. The pension fund installed a modest in-house infrastructure team, and began researching the asset class with a view to manager selection rather than direct investment.

But by then, CalSTRS, as well as the rest of the pension plan community, was facing a more substantial challenge than performing good due diligence.

CalSTRS suffered through 2008 with a 25 percent loss followed by a 3 percent loss in 2009. The pension fund returned 12.8 percent in 2010 before dropping to 2.3 percent in 2011, when it made its maiden investment in infrastructure. That April, CalSTRS committed $150 million to First Reserve Corporation, the Greenwich, Connecticut-based buyout firm that had launched a $1.2 billion energy infrastructure fund.

The First Reserve allocation was indicative of what CalSTRS wanted to do with infrastructure—gain exposure to the asset class by way of using its prowess in manager selection.

Rigorous selection of a core infrastructure manager followed. This comprised a six-month process which included an on-site visit to each prospect, according to someone familiar with the search. CalSTRS wanted diversification across infrastructure in North America and Europe, including energy and transportation.

STAGGERING

When CalSTRS picked IFM, the pension fund decided to stagger its investment, with an initial $300 million tranche followed by a further $200 million in capital spread through 2013.

IFM, which is headquartered in Melbourne, Australia, was created as an infrastructure investment entity for a 32-member superannuation collective and has $31 billion in total capital, as well as $10 billion dedicated to infrastructure. The superannuation sector in Australia, according to Ailman, “pioneered” infrastructure investing using the benefit of scale to leverage returns.

CalSTRS, meanwhile, has earmarked 2.5 percent of its capital, or $3.5 billion, to infrastructure. It has made no secret that, ultimately, it will look beyond funds to direct investment. But, for now, it’s a case of safety first: and IFM will be popping open the champagne as a result.