There is a huge imbalance in Australia between demand from super funds and supply of infrastructure projects, writes David Uren
AUSTRALIAN super funds are heading overseas to invest in infrastructure projects because of a lack of opportunities at home.
Investment managers establishing offshore funds for superannuation investment include Industry Fund Services, AMP Capital, Hastings and Macquarie Bank, while there are about 10 investment managers with substantial overseas infrastructure holdings.
Some of these funds expect as much as half of their infrastructure investments to be offshore over the next year or two.
IFS executive chairman Garry Weaven blames both the commonwealth and the state governments for the lack of deals at home.
"The biggest constraint for us is deal flow, and the problem has been a lack of political leadership. Most of the deals need some political involvement."
Weaven says the commonwealth has failed to grasp the nettle of greenhouse change, and has not supported investment in renewable energy projects. Nor has it provided opportunities for private capital to help shift freight from roads to rail, while there is a large shortfall of investment in water projects.
"And then there are the crazy debates in the Labor Party about the degree to which you want private sector involvement," he says. "They are debates occurring among a tiny pool of people that no one else is interested in but which are constraining Australia's development."
Infrastructure investment has moved from a fringe activity for super funds to a distinct asset class, and the asset consultants, such as Mercers and Jana, are building capability to analyse infrastructure investments.
Mercer has based its global infrastructure consulting in Sydney and its head of alternate investments, Dragana Timotijevic, says there is a huge imbalance in Australia between the demand from the super funds and the supply of projects.
"In Europe and the United States, it is the other way around," she says.
Whereas there have been estimates that Australia's infrastructure requirements may total $120 billion over the next 20 years, the US or Europe would have projects between $300 billion and $500 billion in the next five years.
Timotijevic says it would be reasonable for superannuation funds to have between 5 and 10 per cent of their assets in infrastructure, which, would translate to between $50 billion and $100 billion for the industry as a whole.
She estimates their infrastructure investments through unlisted trusts and direct stakes at about $15 billion. "They are massively under-invested in the sector."
Holdings in listed infrastructure securities may add a further $30 billion to their exposure to the sector.
The long life and steady earning nature of infrastructure assets make them well suited to superannuation funds. Head of the Australian Centre for Public Infrastructure, Michael Regan, says infrastructure assets are a good diversification for super funds. "It is correlated with short-term interest rates but not much else."
Direct property investment fluctuates with the overall health of the economy, while indexed bonds move with long-term yields. He says it is very high yielding for an asset with low volatility.
The superannuation fund most focused on infrastructure is the MTIA fund, which returned 19.7 per cent last year. It is advised by Access Economics. It has about 40 per cent of its portfolio in infrastructure and alternative assets.
Access Economics chief strategist Ric Simes says the easiest assets for super funds to buy are marketable securities, however, they cover a relatively narrow part of the economy.
"Infrastructure, because of who has owned it or the nature of it, includes a lot of the non-listed part of the economy. It opens a broader investment space for the funds which is important, both for the opportunities in earnings and also diversification."
Several large funds, including Unisuper, QIC and the Victorian Funds Management Corporation are building their own capacity to appraise infrastructure deals.
Many more are following the advice of asset consultants and buying units in unlisted trusts operated by investment managers such as Hastings and AMP Capital.
AMP Capital infrastructure portfolio manager Paul Foster says his funds have achieved 13 per cent returns on average over the last 11 Years.
Weaven says the the surge in infrastructure spending announced in recent state budgets will help, however, most of this will be government funded, with relatively little private involvement.
Many of the public-private partnerships have much smaller equity components than one would think.
A toll road, which is vulnerable to changes in road traffic projections, requires a large tranche of equity.
However, deals such as a partnership to build a hospital may have a $500 million price tag, but because the income flow is a contracted and certain service fee, it may need only $50 million in equity.
Weaven strongly defends the contribution which private investment has made to infrastructure.
"Airports were a total federal monopoly with a single authority engendering no competition between different city airports.
"Private investment in airports has been fantastic because the owners and operators have been many times more effective in getting traffic movement through the airports, and developing ancillary services and land."
He blames the debacle of Sydney's Cross City Tunnel squarely on the state Government, which he says never sold the objective of getting traffic out of the city. "Investors were not prepared to stand up and lay the blame where it should have been placed, on the Government."
The high fees extracted by merchant banks for structuring private infrastructure deals have contributed to their poor public reputation.
Weaven puts the high fees charged by organisations like Macquarie Bank down to their skill at originating deals in an under-supplied market.
"If governments were better at facilitating deals, making them more straightforward and simple, a lot of the fees would come out. We try to lead fees downward for our clients, but we are often dependent on merchant banks for deal origination."
He cites the example of Melbourne's Spencer Street Station, which was a deal done by a merchant bank, ABN AMRO, and the builder Leightons. IFS bought in on behalf of industry fund clients after the station was built. "The construction difficulties with that project show it is sometimes good for the public sector to shift risk to someone else."
"Our position was to be satisfied with a much lower yield deal, with a lot of those risks being taken by others up-front."
AMP Capital's Paul Foster says the level of fees is not so much an issue as the alignment of the interests of the manager and the investors. Managers such as AMP Capital and Hastings do not charge investors a transaction fee, but gain their returns in line with the long-term performance of the asset.
Foster takes a broad view of infrastructure investments based on their risk profile. He includes assets such as student housing, but not a power station selling commodity electricity into the grid at the market price.
However, the privatisation of the generators of NSW and Queensland are the biggest deals that the investment industry would like to see.
Funds managers also point out that Australia has relatively few private ports, while most of its water assets are still in public hands.