As 140 delegates gathered for Infrastructure Investor’s recent Tokyo Forum 2015, anticipation was etched into the faces of those who, in many cases, had never had the opportunity to share so openly their struggles, ambitions and amusement at how ‘lost in translation’ the rest of the world seems to become when approaching their homeland.
In a context of abundant opportunities brought about by Asia’s unprecedented rate of urbanisation, questions were raised about Japan’s leadership in the making of tomorrow’s urban landscape. If Japan’s institutional investors do not have the experience of infrastructure financing found in other OECD economies, as all present seemed to concede, why is Japan not honing such skills by transferring its indisputable technological edge and financial know-how to smart city technology?
“For more than 30 years, Japan’s government has discouraged growth in Tokyo, and tried to develop the countryside with massive transfers. The Tokyo Olympics and urban Special Economic Zones are now driving overdue infrastructure upgrades and internationalisation,” highlighted Martin Schulz, a senior economist at Fujitsu Research Institute.
Tokyo benefits from Olympics investment until 2020, but the warning was voiced that much follow-up work would be needed to instigate the financial revival hoped for by the government. “Sadly, Abenomics is already showing signs it will not bring the economic bounce back that was promised,” says Schulz.
Rapid urban development
With urbanisation in emerging markets (EM) happening ten times faster, at 300 times the scale and roughly 3,000 times the impact of the Industrial Revolution, Japan could well find itself at the forefront of a new Copernican revolution.
By 2025, China will be home to more large companies than either the US or Europe, with nearly half of the world’s top-tier revenue to be headquartered in emerging markets. EM cities will account for up to 33 percent of global GDP.
Where does Japan stand amid this whirlwind? Schulz delved into a case study of Siemens, which had been losing margins on its core business model, and had to venture beyond its traditional business strategy. It has recently won important deals courtesy of groundbreaking adaptations of its technology to smart city infrastructure, reaping a coveted contract to provide airport cargo, city terminal, and traffic control systems to the city of Bangkok.
The need for social infrastructure should not be overlooked either. Ajay Sawhney, chief executive of IDFC Capital (Singapore), reminded delegates that one school a day had been opening in India for the past 14 consecutive years.
Japan wants to create opportunities for old age homes and healthcare upgrades. Plus: “Many public buildings need renovation, as well as bridges and roads, but domestic reform needs to occur first,” said Hidekazu Ishida, from Osaka Oil and Gas Employee Pension Fund. “In Japan, we love to invest in public-private partnerships (PPP) and Private Finance Initiative (PFI), but we need certain regulatory issues sorted. The construction phase needs more transparency,” he contended.
Is Japanese infrastructure investible?
Mitsuho Arakawa, executive consultant at Russell Investments Japan and Hidekazu Ishida, advisor at Osaka Gas Corporate Pension Fund, stressed the need for government to create attractive core infrastructure investment opportunities for domestic and foreign investors alike. “Long-term tax breaks on investments in core infrastructure assets could be created, in much the same way that advantageous feed-in tariffs for renewables have been put in place in 2012 by the government,” Ishida suggested.
For Hisashi Hatta, AISIN Employees’ Pension Fund managing director and investment director, the lack of local expertise, coupled with the need for more regulatory reforms, are real deterrents to investing at home. Direct investment is not a viable avenue either, because of small ticket sizes.
Currently the pension fund invests all its capital through a total of 10 funds: six closed-ended single manager equity funds, one fund of funds, two debt funds and one emerging market fund with assets in Asia and Latin America, most of which have a lifespan of 10 to 15 years.
He is still looking for additional funds to increase his portfolio, but is looking outwards in seeking partners with a special focus, whether geographic or sector oriented. In the short term, his attention is geared towards closed-ended funds with social infrastructure mandates, with assets built or operated via PPPs.
When doing due diligence and investigating GP performance, Hatta does not like to rush – a message hard to get across to GPs who ought to be sensitive to the need for exhaustive information and time for LPs to deliberate, he muses.
Hatta’s current infrastructure allocation is $50 million but he plans on increasing his portfolio by an additional $5 million to $10 million this year. Average IRRs within the funds range between 10 and 15 percent and cash yields from 5 to 6 percent, with slightly lower expectations on the debt side.
The trustee perspective: different needs, different strategies
For Resona Bank’s senior investment manager, Takako Koizumi, what a GP must bear in mind when addressing Japanese pension funds is the diversity of their needs in today’s economic context.
Some pension funds will want to hedge against inflation risk and choose infrastructure for that reason, while others will consider infrastructure as a long-term investment which they can receive a liquidity premium from, while others will look at the asset class as an alternative to investment-grade bonds.
“These different requirements need us to pursue different strategies. For instance, senior debt infrastructure funds will be a good investment route for pension funds looking for alternatives to investment grade bonds.”
“If a Japanese pension fund wants to maintain stable income, which is a characteristic of bonds, while achieving higher returns than senior debt, junior/mezzanine debt infrastructure fund would be preferable.”
“Considering the increasingly competitive market environment, especially in some core assets, it could be an option for Japanese pension funds to select a fund which invests not only in core infrastructure (the return from which is presumed to be lower than before) but also GDP-linked assets as long as the GP can accurately presume long-term future cash flow from such GDP-linked assets,” says Koizumi.
In general, Japanese corporate pension funds’ target returns are relatively lower (usually 2 to 3 percent) and many core or core-plus managers believe their return will be around 10 to 12 percent, stretching to 13 percent, but Koizumi believes some funds will fall shy of this given the competitive market conditions. Although some Japanese pension funds invest in infrastructure to stretch their returns, they typically invest in infrastructure for diversification and stabilisation of their portfolios, she says.
As to choosing the right GP for the asset class, there is an added difficulty, she argues. The difference with traditional investments such as listed stocks and bonds is that GPs cannot replicate the same portfolio as the one they have built for previous funds. Because of this, a GP’s track record isn't enough and the bank also needs to look at sourcing skills and asset management expertise.
“As to a GP’s sourcing skills, we try to grasp how a GP sourced the transaction, how and who initiated each transaction in the team. We will also examine the background of the team members to determine whether the team has enough expertise in the industry,” she explains.
“In order to determine a GP’s managerial expertise, we look at how a GP creates value on the underlying investments/assets. We analyse past performance, and investment experience very carefully, to determine whether or not past investment performance would be achievable in the next fund,” Koizumi explains.
Mitigating foreign exchange risk in Southeast Asia remains Japanese groups’ biggest stumbling block to investing in the region.
Despite strong interest, there is consensus around an unwillingness to bear currency risk, with Japanese LPs preferring to allocate resources to countries in Asia and Latin America which can guarantee US dollar-denominated transactions.
However, some think Japan would do well to pursue opportunities at home, in spite of regulatory obstacles, in order to gain traction abroad. Thierry Déau, founding partner and chief executive officer of Paris–based fund manager Meridiam Infrastructure, said:
“The Japanese have been exporting their capital for many decades but you cannot expect the world to follow you so easily when you are not willing to invest in your own backyard.”
“Turkey is a good example of an opportunity that we weren’t scared to go after despite hurdles being in the way. It took us three years to close this seminal hospital deal. It unlocked a programme of about €12 billion of investment from the Turkish government,” said Déau.
“This investment necessitated a significant change in healthcare policy from the government. Now the contracts are top notch, with lenders of the same quality as the IFC allowing our investors to access an excellent pipeline of deals at good returns to compensate the risk taken for investing in Turkey,” Déau asserted.
The conclusion was that one shouldn’t be afraid to break local barriers. “In any new country you can create an investable environment and it’s not so much about the country risk as a question of who’s going to work with the government to unlock the potential pipeline of opportunities. I would just love Japan to become a country with lots of infra projects,” he argued.
Similarly, Andrew Bishop, a partner at US fund manager Alinda Capital Partners, believes that despite Japan’s successful track record at exporting its capital, further inroads could still be made, perhaps drawing on examples from Asian neighbours.
Investment professionals from Nomura and Sumitomo Corporation conceded on the sidelines of the conference that they felt the need to partner with others to gain the relevant expertise and were looking towards OECD countries for this.
For Yoshihisa Shimizu, manager at Sumitomo Corporation, a factor at the root of Japan’s slowness in opening up its market is its tendency not to react to any situation which is not viewed as dire. “We have always looked outward to learn from the rest of the world only when things looked very bad. And we will do it again. But once we start, we learn fast,” he exclaims with a smile.
Scale and cultural awareness are of the essence
In Asia, opportunities exist everywhere as demand is phenomenal but there are still challenges with regard to turning these opportunities into deals. Canada’s PSP Investments stressed the need to find the right partner for a specific set of opportunities. “One of our challenges is to tailor our investment strategies to the realities of specific jurisdictions and tap into these mid-market, smaller ticket-size opportunities,” said Gabriel Damiani, manager at the firm.
According to Damiani, the cultural element is very important because of the long-term view inherent in infrastructure investments. “We are long-term investors and as such put great emphasis on building strong relationships with our local partners. It sometimes takes time to bridge the cultural gap between Canada and new markets, but we need to ensure we are fully aligned in terms of interests and investment horizon. An example of that is where we spent close to a year in due diligence and getting to know our partner prior to acquiring a portfolio of assets located in seven different jurisdictions. This transaction was a great opportunity for us to learn more about the targeted geography’s culture and ways of doing business.”
According to an industry source, the importance of unwritten codes of conduct such as word of honour are fundamental when it comes to traditional institutions choosing a business partner.
Where a contract is not going smoothly, a Japanese firm will be very sensitive to the way a partner handles any review of the relationship. There is often a perception that American firms for instance will use their right to unilaterally end a contract at the first opportunity they see fit, whereas a Japanese counterpart would opt for a softer approach and actively manage a relationship before the situation gets too conflictual. “The way of approaching bumps along the road weighs considerably on our decisions when looking for suitable partners to develop business with,” the investment manager conceded.
Another idiosyncrasy lies in decision-making processes. The decision will not necessarily be made by the highest-ranked executive in a company or division. The importance of engaging as much as possible with business partners is vital, and it means not assuming anything. It is crucial to dare to be candid about not knowing, the audience was told.
Perhaps the best recommendation when engaging with this unique market is to be found in the most universal of rules: “Treat others as you would wish to be treated.”