The right structure

Alceda’s Michael Sanders examines how investors can benefit from innovative financing in the real asset space.

Much has been made of so-called real assets such as precious metals, commodities and agricultural land. They are particularly popular in an inflationary market because of their tendency to outperform traditional financial assets during such periods and, with investors’ risk appetites fluctuating with the markets, real assets offer the potential of lower overall portfolio risk and better long-term risk-adjusted returns.

With current low interest rates, institutional investors are being forced away from traditional forms of real asset investment to look for new opportunities. Two areas gaining increasing levels of attention are infrastructure and renewable energy.

So should institutional investors consider these particular real assets, and if so, what is the most effective way to do so?

There are undoubtedly some attractive opportunities to invest in energy infrastructure as has been shown in Australia and Canada where pension funds have been active in infrastructure investment since the early 1990s. These two countries have the highest asset allocation to infrastructure by pension funds (of roughly 5 percent) across the globe.

According to a recent OECD paper “Pension Fund Investment in Infrastructure: A Comparison between Australia and Canada”, OECD Working Papers on Finance, Insurance and Private Pensions, No.32, OECD Publishing, July 2013, the main investment drivers are low regulatory risk, the ability to have greater control over assets and a lower cost burden.

The OECD concludes that the “Canadian model” and the “Australian model” of infrastructure pose a significant challenge to the dominant European and US “private equity model” but that ‘important lessons can be learnt by both policy makers and investors’. What is of particular interest are the different ways funds in each market invest in infrastructure.

In Canada most pension funds invest abroad, while in Australia around 50 percent is invested in the domestic market. Despite the high levels of investment, the OECD study highlights the need to bring in external investment expertise and to work with a leading energy investor.

However, at the moment, the main barrier to investment is uncertainty regarding regulatory implementation coupled with inconsistent or contradictory tax regimes across geographies. Adjustments to Basel III and Solvency II are important conditions for positive investment decisions and to creating a positive fiscal environment that supports infrastructure and renewable energy investment. It is crucial that investors choose a suitable approach, and one that fits with their own investment objectives as well as within the wider regulatory framework.

One approach that is particularly attractive is for institutional investors to co-invest with an energy company. This is a positive for both the energy company and the investors. At a time when energy companies need additional funding in order to achieve their renewable energy targets, they can secure additional funding through the sale of shares and also avoid full consolidation of their liabilities in their group accounts.

But for this approach to work well there needs to be a sound understanding of risk/return profiles, the different company cultures and of the wider regulatory requirements. In this instance it makes sense for investors to have an independent third party to manage and lead the project.

The examples of Canada and Australia demonstrate how institutional investors can work closely together to develop innovative financing partnerships. The “Canadian model” of direct investment shows that institutional investors need to understand the complexity of the energy market and must have the appropriate resources available.

Institutional investors have discovered the opportunities offered by infrastructure and in particular, how they can benefit from the global energy revolution. However, in order to maximise these prospects, it is crucial that investors choose the right structuring vehicle in order to gain access to the appropriate real assets.

*Michael Sanders is chairman of the board at Alceda Fund Management, a Luxembourg-based structuring specialist.