Revisiting Infrastructure - Does It Still Make Sense For Pension Scheme Investment?

Private & Confidential Investing in Infrastructure 24 June 2014 1

REVISITING INFRASTRUCTURE –

DOES IT STILL MAKE SENSE FOR

PENSION SCHEME INVESTMENT ?

Private & Confidential Investing in Infrastructure 24 June 2014

Investing in Infrastructure – everyone’s doing it!

2

Friends Life

• £500mn mandate with Met Life

• To invest in UK-based senior secured bilateral loans

• To back UK annuities

• Met Life also backed by other UK mid-sized insurers

Lancashire County Pension Fund

• £12m bond in community-owned solar power

station in Oxfordshire

• Part of debt financing for project

• Index linked debt with a 23-year repayment period

Universities Superannuation Scheme

• £5bn bid for Severn Trent

• Also involved Kuwait Investment Office and Borealis

Infrastructure

• Largest direct investment by British pension fund in

UK infrastructure

Devon Council Pension Fund

• £40m in Aviva Investors’ Returns Enhancing and

Liability Matching funds

• 50/50 investment in REaLM Infrastructure Fund

and REaLM Ground Rents Fund

• Long-dated investments with inflation protection

BT Pension Scheme

• Minority equity stake in Thames Water

• Shareholding in Kemble Water Holdings Limited

• Illiquid investment with a natural link to UK

inflation

Stanhope Pension Trust

• Large mandate with Allianz Global Investors

• Investing alongside Allianz and EIB

• Part-funded M8 motorways improvement project

in Scotland via new PFI debt

• First investment of this kind by a UK pension fund


Benefits of allocating to infrastructure debt – higher spreads (but falling)

3

0

50

100

150

200

250

300

350

400

Asse

t S

wa

p S

pre

ad

BAML £ Corp & Collateralised

Liquid corporate bond spread as

of 9 May 2014 = 118bps

Approximate premium over liquid

bonds = 75bps

Approximate return on core

infrastructure = 193bps

Approximate return on opportunistic

investments = up to c. 240bps,

case by case

Comparison of Pricing on Private Infrastructure Loans vs. BAML £ Corp & Collateralised


Benefits of allocating to infrastructure debt – lower default experience

4

Default Rates on BBB-rated infrastructure debt are consistent with those experienced in A-rated corporates

Furthermore, ultimate recoveries on defaulted debt average 80%, and in 65.3% of cases defaults were

restructured without loss. The takeaway is lower default losses than the BBB-rating would suggest.

Source: AllianzGI and Moody’s


Benefits of allocating to infrastructure debt – role in a terminal portfolio

5

Corporate

Bonds

Direct

Lending

Corporate

Linkers

Infrastructure

Debt

Long Leases /

Ground Rents

Gilts

Cash


Challenges of allocating to infrastructure debt – availability

6

“Despite having dramatically improved capital

ratios in the past four years, European banks

are not done yet, with many ratios below their

long-term target or requiring improvement

because of transitional rules.

As shown, the average Basel 3 Common

Equity Tier 1 (CET1) Ratio* is now within

50bp of the average target, although these

targets continue to go up…

…From a creditor perspective, the continued

bolstering of European bank capital is the

primary positive fundamental force affecting

bank fundamentals.”

Source: Barclays Research, ‘European Banks

– Three Dimensional Capital’, 25 November

2013

* The CET1 Ratio is the ratio of the most junior form of capital

available to absorb losses (typically common equity and

retained earnings) versus risk-weighted assets.

0% 5% 10% 15%

RBS

HSBC

Lloyds

UBS

Credit Suisse

DB

Commerzbank

BNP

SocGen

Credit Agricole

Santander

BBVA

Unicredit

Intesa SP

Goal CET Ratio

European Banks’ CET1 Ratios: Progress vs. Goals**

** Goal is stated company target or Barclays expectation.


Challenges of allocating to infrastructure debt – competition for assets

7

“AXA's plan to invest EUR10bn over the next five years is the most significant

so far from a European insurer. Other insurers that have recently announced

investment plans include Ageas and CNP Assurances, which have both signed

deals with Natixis to co-invest in infrastructure debt, and Allianz Global

Investors who set up an infrastructure debt platform.”

Source: FitchRatings, 19 June 2013

“The RBS Group Pension Fund has allocated an

initial 750 million British pounds (US$1.2 billion) to

Hastings Funds Management to manage and

develop private market infrastructure assets”

Source: Wall Street Journal, 17 July 2012

“Aviva and Legal and General are among the six

insurers that have agreed to collectively invest

£25bn in UK infrastructure over the next five

years”

Source: Professional Pensions, 5 December 2013


Challenges of allocating to infrastructure debt – political uncertainty

8

Budget 2014 widely seen as offering

limited visibility of future pipeline:

• £140m for flood defences

• £200m for potholes

• Guarantee of £270m for Mersey

bridge

• Up to £200m for Ebbsfleet Garden

City

• £100m for Greater Cambridge

• £20m for Cathedrals


Challenges of allocating to infrastructure debt – regulatory uncertainty

9

The FTSE 100 company said sales of

annuities, which allow pensioners to

convert retirement pot into income, had

fallen by half since the chancellor unveiled

the shake-up in the budget six weeks ago.

Source: Financial Times, 30 April 2014

Greater Flexibility at Retirement for DC Pensioners

Decrease in Demand for Annuities

Decrease in Demand for Long-Dated Assets by Annuity Providers

More DB Members Shift Retirement

Savings to DC Schemes

Liquidity Issues for DB Schemes &

Decreasing Demand for Long-Dated Assets

Mitigating factors for infrastructure debt:

• Active secondary market.

• Many deals in <20yr maturity bracket,

hence not always ultra long-dated.

• Loans are often amortising.

• Bulk annuity market remains robust.

Potential Implications of the End of Compulsory Annuitisation


Challenges of allocating to infrastructure debt – time to invest

10

Factors Decreasing Deployment Time:

• Wide coverage of borrower universe

• Direct origination capability

• Global mandate

• Few concentration limits

• Manager has full discretion

Factors Increasing Deployment Time:

• Restricted to certain borrower types

• Secondary portfolio only

• UK-only

• Strict portfolio concentration limits

• Manager needs sign-off for each deal

Away from certain high-

profile failures, we are

aware of several investment

platforms which are

functioning strongly and

have succeeded in putting

capital to work in senior

debt.

Broadly, we would consider

a period of c. 12-18 months

sufficient to invest a

portfolio of £200m+ across

7-10 assets in both bilateral

transactions and greenfield

projects.


Challenges of allocating to infrastructure debt – what is the right approach?

11

Primary Bilateral

Transactions Secondary PFI Primary PFI

Target Return Higher Lower Medium

Origination Fee Yes No Yes

Speed of Execution Slower Can be fast if seller can

be identified Slower

Flexibility over Deal

Structuring Yes No Yes

Prepayment Protection Usually negotiable No Deal Dependent

Construction Risk

Buy-out friendly?

Deal Dependent

Generally

Typically Not

No

Yes

Sometimes


Challenges of allocating to infrastructure debt – the various access options?

12

Independent Managers

Insurance Parents

Bank-Owned

Infrastructure Equity

Background

Smaller Start-ups

• Many solution providers are managers

with a significant insurance background,

or banks, seeking to find institutional

partners to help them overcome the

various Basel III challenges to holding

long-dated infrastructure debt on the

balance sheet.

• A number of providers come from an

infrastructure equity background (many

of these are Australian in origin) and

there are also a number of smaller start-

ups, typically formed by bank

infrastructure teams seeking a new

home.

• We feel that given the long-dated and

illiquid nature of infrastructure debt

assets, the corporate stability and

longevity of an investment platform is key.

Private & Confidential Investing in Infrastructure 24 June 2014 13

Conclusion


Does Infrastructure Debt Still Make Sense For Pension Scheme Investment?

14

• Infrastructure debt makes sense for pension scheme

investors. It offers many attractive features, including:

• Liability-matching characteristics

• An illiquidity premium over comparably-rated

corporates

• An appeal to buyout providers if structured correctly

• The market is moving fast and allocating is not trivial –

allocations should be made via a specialist manager with a

strong understanding of the client’s goals in allocating to

the space.


2-6 Austin Friars, London EC2N 2HD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk

Contacts

Pete Drewienkiewicz Head of Manager Research

Direct Line: 020 3326 7138

[email protected]

15

Disclaimer

For professional investors only. Not suitable for private customers.

The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other reference

rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf. Unless otherwise stated, any pricing information in this document is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs. Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence. This presentation may not be copied, modified or provided by you , the Recipient, to any other party without Redington Limited’s prior written permission. It may also not be disclosed by the Recipient to any other party without

Redington Limited’s prior written permission except as may be required by law. “7 Steps to Full Funding” is a trade mark of Redington Limited. Redington Limited is an investment consultant company regulated by the Financial Conduct Authority. The company does not advise on all implications of the transactions described herein. This information is for discussion purposes and prior to undertaking any trade, you should also discuss with your professional, tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect of tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate.

Registered Office: Austin Friars House, 2-6 Austin Friars,, London EC2N 2HD. Redington Limited (reg no 6660006) is registered in England and Wales. ©Redington Limited 2014. All rights reserved.

Investment Consultancy

of the Year 2014

Investment Consultant of the

Year 2013

Investment Consultant of the

Year 2013

Best Investment Consultancy

2014

Risk Management Firm of the

Year (2012); Investment

Consultant of the Year (2013)

European Pensions Awards

Investment Consultancy of

the Year 2014

Economy & Finance

Revisiting Infrastructure - Does It Still Make Sense For Pension Scheme Investment?