Luring super funds to infrastructure

By Michael Hanna - 30 March 2011

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Australia’s superannuation funds are missing compelling infrastructure investment opportunities in their own country with their focus offshore.

This article by IFM's Michael Hanna was first published in the March 2011 issue of inFinance and is re-produced here with permission.

There has been a significant amount of debate recently about how to unlock the substantial wealth in the Australian superannuation sector and apply it to the much publicised $700 billion ‘infrastructure gap’ in Australia.

The anticipated increase in the delivery of major infrastructure projects has failed to materialise in spite of the creation of a new Federal agency, Infrastructure Australia, and the availability of funding through the Building Australia Fund. The continuing growth in superannuation funds creates an appetite for infrastructure investments. The question is how to get these funds to invest more in this sector.

While the present public and political debate about superannuation funding brings much needed attention to the infrastructure needs of Australia, it appears to have been over-analysed and somewhat misunderstood. Numerous ‘solutions’ have been proposed without completely understanding the reasons behind the ‘gap’.

Infrastructure

Australia’s $1.3 trillion superannuation sector is the fifth largest pool of superannuation funds globally and is forecast to grow to at least $3 tn over the next 10 years. The match between superannuation funds’ long dated liabilities and infrastructure’s long-term stable earnings streams is well known. Superannuation funds are invested in some of Australia’s most high profile and critical infrastructure assets including the major city airports, toll roads, the power sector and ports, including the Port of Brisbane which was sold by the Queensland Government in November 2010.

The superannuation funds’ long term perspective in owning infrastructure assets is not just theory. Brisbane Airport, for example, majority owned by superannuation funds, is progressing a 14 year, $1.2 bn second runway project. Industry funds’ ownership of the leading Australian renewable company, Pacific Hydro, has also supported the development over the last seven years of more than $1 bn of new run-of-river hydro projects in Chile.

Greenfield projects

Most infrastructure investing by Australian superannuation funds has been in brownfield assets – assets that are already built and operating. Superannuation funds have also invested in greenfield opportunities, particularly Public Private Partnerships (PPPs), but the volume of investment has been lower due mainly to the much smaller size of the projects and high levels of leverage. The attractiveness of brownfield over greenfield assets include:

  • Lower risks given there is no construction exposure and there is an observable operating history
  • The usually narrow spread in returns between brownfield and greenfield projects allows superannuation funds to meet their return hurdles but with much less risks
  • It is easier and less complex to transact with brownfield acquisitions taking three to six months than 12-24 months for a PPP.

Analysis of superannuation funds investing in Australian infrastructure, also has to recognise that the funds are global investors. For any new ‘Nation Building’ projects proposed for Australia, the investment return must be compelling, relative to brownfield opportunities globally.

Alignment and deal flow

The preferred route to deliver new infrastructure in Australia is via PPPs. Superannuation funds have invested in PPPs such as Southern Cross Station, Defence headquarters and Perth courts.

But while the funds have invested in these projects and own many outright, they have not been the sponsor of these PPPs in that they have not played the lead role in putting the bid together and taking the risk on the bid’s success. The key reason is the complexity and costs of the bidding process which require large, specialist teams. When combined with the relatively low amount of equity that features in the capital structure of PPPs, the business proposition is not compelling. The entities that are most motivated to resource these bids are the financial advisers and building contractors.

PPPs are typically led by investment banks and contractors and they attract ‘third party’ equity to support the projects. Investment banks and the contractors, however, have a short-term focus and will generate their returns either on financial close or during the construction period. A long term equity investor, such as a superannuation fund, on the other hand, will be focused across the entire concession period of up to 30 years.

This issue of alignment between the project sponsors and project investors has been brought into sharp focus with the recent high profile toll road failures of the Lane Cove Tunnel in Sydney and Rivercity Motorway in Brisbane.

The party with the most equity at risk on the ‘opening day’ has been long term equity and not the two parties that built the asset and have already made their return.

To date, deal flow has been low with around four PPPs a year.

A solution is for superannuation funds, through their investment managers, to bid for PPPs in their own right. In a strong market, with lots of opportunities available, the business proposition would be compelling. With the existence of at least four credible, and well resourced, bidding groups, the market is crowded.

Alternative model

A PPP procurement model that motivates and incentivises long term equity investors to sponsor bids would ensure a much more sustainable approach. Who better to sit down and negotiate a 30-year contract with government than proven long term equity investors?

The model would require the government to identify its long term equity partner at the outset. Key criteria would include financial capability, a track record in infrastructure ownership and partnerships, and risk appetite and return expectations.

Together, they would procure the debt, the contractor and the facilities manager on a competitive basis.

This model would provide the required ‘signal’ to superannuation funds and their investment managers to take a lead role in the delivery of major new infrastructure projects in Australia.

Addressing the gap

The PPP route to funding new infrastructure should not be the only focus. Governments have the opportunity to ‘recycle’ the capital presently locked up in their infrastructure assets. The Queensland Government’s recent programme of asset sales is an example where the proceeds will be used to fund new capital projects.

Governments could also continue delivering capital projects through their normal capital programs but transact early with long term owners to acquire the asset on completion.

From a policy perspective, new private sector investment opportunities in the power sector, renewables, and water sectors could be created to address capacity shortfalls, upgrade plant and meet carbon emissions targets. The alternative is a continuation of Australian superannuation funds investing tens of billions of dollars, for example, in power assets in the United States, water companies in the UK and hydro projects in Chile.

Any failure to link the superannuation system to our national infrastructure needs is not an unwillingness of superannuation funds and their investment managers to meet the challenge. The large scale and rapidly growing industry funds, in particular, have a strong appetite for such investment and in 2010 alone, Industry Funds Management (IMF) industry fund investors supported almost $900 million of direct infrastructure investment in both Australia and overseas. If things continue as they are, it will be a significantly missed opportunity if a good proportion of our world-leading superannuation base is not harnessed to create world-leading economic, social and environmental infrastructure.