Asset Manager Allocations to Infrastructure Continue to Increase
A notable feature of the global financial industry after the 2007-08 crisis has been the growth of the shadow banking system, which now rivals the traditional banking sector for total assets under management. Shadow banking includes pension funds, insurance companies, asset management companies, sovereign wealth funds and the like. Infrastructure funds in particular have been growing rapidly.
This growth has become the subject of considerable attention from central banks generally, and by the Bank for International Settlements (BIS) in particular. The concern of central banks is whether this growth is creating a build-up of systemic risk outside the banking system, in a sector that is less regulated and less transparent than banking. There is also the potential for the asset management companies in the shadow banking system to amplify pro-cyclical swings in the financial system and wider economy.
The annual reports from the BIS have been documenting the rise of asset management companies. In the 2016 annual report they say:
… concerns over market liquidity have come to the fore (Chapter II). They have highlighted the role that institutional investors and collective investment vehicles may play in future market adjustments. Given these institutions' growing allocations to corporate bonds and other comparatively illiquid assets, their portfolio decisions may challenge market liquidity under stress. This raises the question of whether regulation has kept pace with these players' increasing importance.
Asset managers' assets under management have been growing steadily in recent years (left-hand panel), signalling a large increase in the potential demand for liquidity. Funds that promise daily redemptions have been quite prominent, as suggested by the increasing presence of open-end mutual funds in corporate bond markets. Investors may thus find that liquidating positions proves more difficult than expected, particularly when market sentiment turns. An example is the May-July 2013 "taper tantrum", when bond funds faced significant redemption pressures (right-hand panel)
According to the 2015 Towers Watson report, total assets under management (AUM) by the top 500 fund managers reached USD$78 trillion in 2014. The top 20 asset managers have 41%, and the top 50 nearly two-thirds of that total, and North American firms dominate - BlackRock has been the largest asset manager in their ranking for 5 years, with Vanguard second and State Street displacing Allianz from third in 2015. Equities and fixed interest securities of course dominate, but there has been significant growth in the real estate and alternative categories. Infrastructure is usually classed as an alternative asset class.
A 2014 OECD report on institutional investment in infrastructure observed that “The greatest change in the growth of the market occurred between 2005 and 2006, when the aggregate capital raised more than doubled from $9.4 billion to $21.8 billion and the number of funds increased from 20 to 33. Between 2006 and 2007, while the number of funds in the market only increased by seven, the aggregate amount of capital raised increased 93% from $23.8 billion to $44.8 billion.” With the global financial crisis in 2009 number of funds dropped and capital raised declined before rebounding in 2010, as the graph below shows.
In 2012 Global Infrastructure Partners (GIP) raised $8.25 billion (all amounts in USD), setting a record for the largest fund raising to date. Recently, Brookfield beat GIP with a new record $14 billion fundraise for its third infrastructure fund. However, GIP has already raised over $10 billion for its own third infrastructure fund, which has a target of $15 billion. Between them GIP and Brookfield will have raised $29 billion in 2016, so far.
As an asset class infrastructure is growing rapidly. Of the $27 billion raised by Brookfield across real estate, private equity and infrastructure in the last 18 months, infrastructure accounted for over half. BlackRock’s new real assets unit, created earlier this year, combined its real estate and infrastructure businesses, and infrastructure currently only accounts for $8.6 billion of the new unit's $29 billion AUM and is targeted for growth. This is another trend to watch, as real estate management capabilities get applied to infrastructure asset management, which will be a determining factor in returns from many investments.
So far pension funds are mostly exposed in equity investments in the regulated utilities of Europe, North America and Australia, in keeping with their conservative, long-term approach. Managed funds are prepared to take on higher risk, and are now looking for higher return investments around the edges of infrastructure, for example gas platforms, mobile licenses and telecom towers, container terminals and power plants.
The 2016 Prequin Global Infrastructure Report commented “The unlisted fund market is more crowded than ever before, with 179 unlisted infrastructure funds in market targeting $120 billion in institutional capital.” In their view, the unlisted infrastructure fund market, while relatively small compared to other alternative asset classes such as private equity and real estate, is growing strongly. Assets under management are $309 billion, with capital available to invest of $108 billion. This leads to a different set of challenges for infrastructure firms looking for opportunities to put this capital to work. Below is their industry overview.
An interesting feature of the growth of infrastructure funds is the apparent shift in the allocation away from real estate. A potential problem for real estate investments in a deflationary world is, unlike infrastructure, their absence of pricing power in lease negotiations if vacancies and unemployment are rising and major tenants are under financial pressure (banks), downsizing (sunset industries), moving domicile (Brexit, tax inversions) or failing. So far, however, demand from digital economy firms (e.g. Facebook, Linkedin) is supporting office markets. While there is regulatory risk with infrastructure, people still pay tolls and other fees related to its use. This may be driving the trend to infrastructure, and if that pushes up prices, returns could drop.
Infrastructure assets have a longer life cycle than real estate assets, with predictable returns over a very long period, which has made them attractive for meeting long term liabilities such as retirement payments. However, new investments may not deliver the returns investors have become accustomed to. There may be more capital available than quality assets, especially with investors well-publicised reluctance to take on development and delivery risks with greenfield projects.
The $100 billion in uncommitted funds, when leveraged up somewhere between 5 and 10 times (the average is around 8), puts well over $500 billion in play. Investor demand many be greater than supply, which would push up prices. The competition for assets will be fierce, as managers are loath to return unused funds and get no bonuses for sitting on the money. On the other hand, there is enormous unmet demand for private investment in infrastructure as countries everywhere attempt to close their ‘infrastructure gaps’, estimated by McKinsey at $800 billion a year to 2030.
Many, indeed most, of the deals done so far have been for existing assets, like the recent sale of over 50% of Colombia’s hydro for $5 billion (Brookfield put up $3 billion of equity), the sale of long-term leases on ports in Melbourne, Sydney and Brisbane in Australia (GIP invested in the Port of Brisbane, manages Q Super’s share in the Sydney ports of Botany and Kembla, and recently gained a stake in the rail assets of Asciano), or Brazil's Petrobras proposed sale of its natural gas transmission assets (possibly $5 billion in equity). The size of these large multi-billion dollar deals means fund managers wanting to compete for the assets have to bulk up and be able to put billions in equity on the table, and at the moment GIP and Brookfield, plus some pension/superannuation and sovereign wealth funds, are generally the only ones capable of writing cheques for such sums.
As the industry has grown and matured (the early closed end funds are now reaching the end of their lives) it may be that increasing size and specialisation will enhance deal selection and pricing. Also, the range of alternatives to the two traditional entry methods for investors, through managed funds and in-house direct investment (pioneered by Canadian and Australian superannuation funds), are increasing. There is a lot of chatter about the potential for infrastructure bonds, for example.
While regulators have a great deal of experience in managing risk in the banking system this is not the case for asset management, where a different mixture of risk and opportunity presents them with a new set of challenges. The high level of leverage found in infrastructure, combined with the illiquid nature of the assets, could become an issue for both the industry and regulators. This argues for a regulatory light touch approach while the structure and performance of the asset management industry evolves. However, in my opinion asset managers will have to accept a greater degree of transparency for such an approach to be justified.
