GlobalInfrastructureFacility(GIF)AdvisoryCouncilMee:ngWashingtonD.C.,20April2017 PensionInvestmentinEmergingand

Fron2erMarketsInfrastructureAssets

INVESTMENT INSTITUTE

Foreword

Theconclusionsandopinionsexpressedhereare theauthor’satpresenta:ondateanddonotnecessarilyreflecttheviewsoftheWorldPensionsForum(WPiF)ortheWorldPensionsCouncil(WPC)anditsmembers

Thisppt.slidedeckisfor limiteddistribu:ontoGlobal InfrastructureFacility(GIF)AdvisoryCouncilMee:ngpar:cipantsi.e.notforoutsidecircula:onorcita:on

Someof the topicsonpg.18 ‘Domes2c&South−SouthEMDE Investment’ (Asianex. JP, La:nAmerican and African pension & SWF investors), ‘North−South and Public/MDB−PensionCoopera2on’ and ‘EMDE Investment as ESG/SDG Ac2on’ (incl. role of pension boardmembers)

reflectforthcomingWPCresearchprojectsthatrequiresupportfromprospec:vegrantors

Part1TheQuestforYields:EMDEInfrastructureintheBroaderContextofPensionAssetAlloca:onI.   FinancialEconomicsSnapshots

II.   HowPensionCIOsViewthe(Investment)World

III.   LookatInfraWithinAlterna:ve&Non-ListedRemit

IV.  UnderstandingUSPublicPensions(State&Local)V.   ACloserLookatSomeUSStatePensions

I.FinancialEconomicsSnapshots(1)

§  GlobalPensionAssets(est.)

Ø  HighergrowthrateforEMPFassets↵Hyp:ìnet$transferfr.govt.budget&SWFsinChina,GCCetc.

§  îAnn.Returnfor‘Typical’NorthernHemispherePFDrivingQuestforYields

Hyp:SimplifiedPI.:60%Bonds+40%Stocks(ListedEq.)

Ø  1985-2007:ARR≈9.0%p.a.Ø  2007-2016:ARR≈5.0%p.a.grossw/ocoun]ngassetmanagement,admin&otherfees

Ø  Netreturn:≈3.0%p.a.,barely>CPIInfla]on…at]mewnpensiondeficitì&demog.crisislooming

Ø  e.g.TheGuardian,Jan.42017:“pensiondeficitoftheUK’slargestcompaniesmorethantrebledto

reach£137bnin2016,despitethestockmarketendingtheyearonahigh…Bondyieldsfellbymorethan100basispointsduring2016,increasingliabiliCesoncompanies’balancesheets… Addedtothis,economistshavewarnedthatinflaConislikelytorisein2017,toaround3%.”

I.FinancialEconomicsSnapshots(2)

§  ThepreponderanceofpensioninvestorsØ  Sizeoftheinfrastructure“assetclass”:roughly$900bn.(WPCest.)

Ø  N°investors:IncludingAUSandNZsuperannua]onschemes,pensionfundsrepresentsnearly40%of

ins:tu:onalinvestorsintheinfrastructureassetclass:privatesectorPF≈17%,publicsectorPF≈15%,mul:-pensionfundinvestors(PGGM,ABP/APGetc.)≈roughly4%(Preqinest.,Adj.byWPC)

Ø  AuM:IncludingAUSandNZsuperannua]onschemes,pensionfundsrepresents30%+ofins:tu:onalinvestors$intheinfrastructureassetclass:privatesectorPF≈5%,publicsectorPF≈12%,mul:-

pensionfundinvestors(PGGM,ABP/APG)≈roughly8%(Preqinest.,Adj.byWPC)

Ø  Total:perhaps$300bn.overallof“infraassets”ownedbypensionfunds(WPCest.)

Ø  Forlargepensionfunds:≈1/3investedthroughinfrastructurefundsvs.≈2/3direct&co-investment

Ø Midsize&smallPFsaccesstheassetclassalmostexcl.thruinfrastructurefunds

§  Aversa:leassetclass,servingbothsidesofthebalancesheetØ  Long-datedreturns:goodforasset-liabilitymatching

Ø  Regular,‘predictable’returns:bond-like&(par]al)hedgeforinfla]onØ  Non-listed,physicalasset:perceivedas‘morereal’thanpaper-money,esp.anertheLehman(US),

RBS(UK),andDexia+For]s(Benelux)debacles

Ø  DiverseESGaspects=sa]sfytrusteesandlabororganiza]ons(andpolicymakers)

I.FinancialEconomicsSnapshots(3)

Source:PreqindatabaseasofDecember31,2016Assetownertaxonomy(‘Type’)adjustedbyWPC

II.HowPensionCIOsViewthe(Investment)World(1)

§  Balancingrisksandreturnsv.carefully,holis:callyØ  ‘Economics’fromGr.nemein:‘tomanage’or‘toallocate’[assets]

Ø Modern‘FinancialEconomics’and‘ActuarialScience’weredevelopedbypensionandinsurance

investorsinFR,ScotlandandNetherlands=>thril,risk-aversion:“1dollartodaybeMerthan2dollarstomorrow”

Ø  CEO,boardmembersi.e.trusteesandregulators(?)remindtheCIOtostayfocused/theseno]ons

Ø  !bothsidesofbalancesheet:assets(usually)asachedtoliabili]esϕ‘matching’(trickyno:on!)

§  Homebias:domes:cassetscomfortzone...andregulatory/govt.zealØ  Currencyhedgingisonenexpensiveorimprac]cal>eatsaway%returns

Ø Moregenerally,CountryRiskisessen]alforpensioninvestorsacrossallassetclasses…

Ø …allmorefor(sovereign)bondsandinfrastructureassets:‘atthemercy’of‘remote’governments

Ø  ‘PutyourselfinPFCIO’sshoes’èpercv.countryasrac]venessΣpoli:cal/legalrisk&econ.return

II.HowPensionCIOsViewthe(Investment)World(2)

§  ‘Poli:cal/LegalRiskAssessment’focusesonfairnessandtheruleoflawØ  Key.esp.when“thegovernmentcanactsimultaneouslyaslong-termlandlord(aswithconcession

contracts),co-investorand/orco-manager,sectorregulatorinfluencingbothpricelevelsandturnover,

client(atmunicipalandlocallevel),lawmakerand,incaseofli2ga2on,judgeoflastresort”

Ø  ‘Ins:tu:onalRisk’“Ameasureoftheindependenceandefficiencyofstateins]tu]ons.10=ins]tu]ons

areextremelyefficientandtotallyindependent.0=stateins]tu]onsarenon-existent.”

Ø  ‘RegulatoryandPolicyEnvironment’“Ameasureofthequalityoftheregulatoryenvironmentandhow

wellpolicyisformulated/implemented.10=v.well-enforcedregulatoryenvironmentandbenevolent

governmentpolicies.0=noregulatoryenvironmentexists.”

Ø  Govt.Non-Payment/Non-Repatria:on“Riskgovt.policiesandac]onsposetofinancialtransfers.10=non-existentriskofgovt.interfere.0=v.highrisk.”Also:Corrup]on,Govt.stability,! accessetc.

§  ‘EconomicReturnAssessment’focusesonLTgrowthandhealthypublicfinancesØ  Economic-GDPoutlook,Governmentfinances,Monetarypolicy/currencystability,Bankstability/risk,

Employment/unemployment

II.HowPensionCIOsViewthe(Investment)World(3)Source:WorldPensionsCouncil(WPC)research+EuromoneyCountryRisk(ECR),Dec.2014,AdjustedforZAF

III.InfrastructureWithinAlterna:ve&Non-ListedRemit

Source:WorldPensionsCouncil(WPC)researchwithUSState&LocalGovernanceExcellence(SLGE)

Part2LearningFrom‘Best-in-Class’PensionInvestorsI.   GeographicDes:na:on:G7/OECDvs.EMDEs

II.   SectorialPreferencesGuidedbyLTP.powerand‘Enhanceability’III.   ‘Alterna:veRoutes’?e.g.Shr.ListedEMDE-OrientedConcessionaires

IV.  EarlySowersintheField:CanadianPensionInvestors

I.EMDEInfrastructure*:Geographic&ProjectStageTrends(1)

10

16

22

26

3331

39

23

26

1315

24

35

9

40

36

52

55

45

3941 40

2.33.7

6.7

7.9 9.2 7.05

14.7

10.713.2

19.5

22.3

27.1

29.2

3.8

25.9

18.0

14.8

25.5

25.3

27.6

35.7

38.9

0

10

20

30

40

50

60

70

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

AggregateCapital($bn)No.ofFun

dsClosed

YearofFinalClose

No.ofEmerging&Fron]erMarketsFocusedFundsClosed

No.ofOECDFocusedFunds

AggregateCapitalRaisedByOECDFunds($bn)

AggregateCapitalRaisedbyEmerging&Fron]erMarkets($bn)

*BasedonInfrastructureFundsTrendsSource:Preqindatabase2007– 2016,WorldPensionsCouncilfor2017est.(ext.Q12017data)

I.EMDEInfrastructure:Geographic&ProjectStageTrends(2)

*BasedonInfrastructureFundsDataSource:Preqindatabase2007–2016,WorldPensionsCouncilfor‘RiskAppe:te’ra:o

II.SectorialpreferencesguidedbyLTP.power&‘enhanceability’

§  Transporta:onØ  Perhaps“theidealinfrasector”formanypensioninvestors,esp.modernrail(‘HS’)androlling-stock,

well-locatedairportsthatcanbeimproved&expanded(PElogic)andsomehighways…butnotall!

§  EnergyandminingØ Mayhaveprofited‘unduly’from1998–2015secularriseinenergyassets,esp.intheMENAarea,

Russia,Peru,Chile,Brazil,Mex.,Malaysia=‘easyreturns’…nonsustainableforbothF.EconandESGreasons

Ø  Butenergytransporta:on&storage+renewables/ESG-driveninfras]llgoingstrong,e.g.Asia+Eurasia,La]nAmerica,Morocco

§  Water,wastewaterandsocialinfrastructureØ  Clearlythe‘parentspauvres’sectors,w/adisaffec]onmoremarkedthaninOECDcountries(think

Flint,Michigan)…why?

Ø Manypensionfundsthinkrightlythatthesesectorsarethemostsuscep]bletopoten]alpopularrecrimina:ons>pressureongovt.fromthepartofusers/voters>pressureeventually

transferredonassetowners/concessionaires

III.Alt.routes?e.g.shareslistedEMDE-orientedconcessionaires

§  Perceivedasappealingalterna:vebysome(midsize)PFtrustees,esp.UK,Spain,FRØ  ‘Weknowthesecompanieswell’…‘Weknowhowtopricethem’…‘Andthey’recheaptoo’!

Ø  Defyingthelawsoffinancialgravity?Youcanseeminglyhaveyourcakeandeatittoo:exposureto

highlyilliquid‘exo]c’assetswhilestayinghome=intheOECDlistedequityassetbucket

Ø  Cheaper,easierandlessrisky?thansaye.g.anEMDEPEfundfocusingontransporta]onsector

§  TherealitymaybeverydifferentinmanyinstancesØ  Assetclassclarityimportant:inspiteofseeming‘overlaps’listedconcessionaires&u]li]esandplain-

vanillamunibondsshouldn’tbecountedas‘infrastructureassets’èthedis:nc:onisn’t‘academic’

èriskofmis-sellinge.g.Mozambique‘TunaFishingInfrastructureBond’

èlisted/liquid+wellnotedbyCRAsdoesn’tmeanrisk-free

Ø ManyUKandSPApensionfundsboughtsharesofAber:s,aninfrastructureconcessionairelistedontheBolsadeMadrid

Ø  Butyoucan’tescapethecountryriskreali:es/metricswemen]onedearlier:

Ø  e.g.Bolivia,wherePresidentEvoMoralesannouncedabruptlyin2013hisdecisiontona]onalizethecountry’smainairports.ThesewereownedandoperatedbyAber]s.Moralesarguedthatthisforeign

investorhadmade“anexorbitantprofitwithaderisorycapitalinput”!

IV.EarlySowersintheField:CanadianPensionInvestors(1)

§  AlbertaProvincePublicPension&SWF:AIMCoØ  TotalAuM:$90.2bn.,only36%non-domes:c…overallonly22%outsideofNorthAmerica

Ø Mostofassetsmanagedinternally=>IM“repatria]on”underLeodeBever,butalsothroughfunds

Ø  Infra:mostly“LTequityposiConsinassetswithregulatedreturnsorlong-termcontractedrevenues”

Ø  Infra:5.8%ofAuM:Chile37%,UK27%,Canada5%,India0.5%,OtherEM0.7%

Ø  Sectors:Transporta:on,IntegratedU:li:esincl.gas*&tolesserext.Telco,Water,PipelinesandRen.ξ5%butì

Ø  FY2015:InfraP}.“returned16.0%netoffees,exceedingitsbenchmarkby10.0%”Yes,but…

Ø  Diversifica:on?Albertaprovides15%ofallnaturalgasusedintheUS…

Ø  Overtheyears,thefundhasinvestedinseveralinfrastructureandprivateequityassetsdirectlydependentonthefortunesoftheAlbertanoil&gassector,thebackboneoftheprovince’seconomyandarathervola]leboom-and-bustindustry.

Ø  GoodGovernance:TheAlbertaHeritageSavingsTrustFundhasarguedthat“thisisnotanaidproject,thisisaninvestment”insis]ngthat,toavoidanypoten:alconflictofintereststhatmay

arise,theprovince’sfinanceministerhimselfisnevertoldaboutafinancialchoiceun]lthedecisionhasalreadybeenmadebythefund’sCIO

§  PublicSectorPensionInvestmentBoard:PSPIB

NB:CPPIBhasav.similarinvestmentphilosophy&assetalloca:on

Ø  TotalAuM:$116.8bn.,morethan70%non-domes:cw/sizeableUSexposurerelistedassets

Ø  Infra:PSP“co-investsgloballyonalong-termbasis,primarilyintransportaCon,powergeneraCon”

Ø  Infra:$8.7bn.=7.4%ofAuM:Europe36%US+Canada21%,UK18%,Lat-Am18%,AsiaexAus.6%

Ø  Sectors:Transporta:on,IntegratedU:li:esfocusingonElectricalPowergenera:on&transmission

Ø  FY2016,InfrastructurePI.disbursed+$1.6billionindirectinvestmentsandexis:ngpla}orms

Ø  July2016:acquiredCubicow/OntarioTeachersasSantanderrealizeditcouldn’tcommitLTcapital

neededforgrowthì:22wind,solarandwaterinfrastructureassetsinopera]on,construc]onor

underdevelopmentacross8countriesincl.Brazil,Mexico,Uruguay≈50%EMDE

Ø Manyoftheseboardmembers=TRUSTEESare(former)schoolteachers,academicsandmid-

rankingmunicipalandfederalcivilservants>progressiveworldview,olenESG/SDGdriven

IV.EarlySowersintheField:CanadianPensionInvestors(2)

Part3TheWayForwardI.   SizeMa�ers:PensionSuperpowersCanShilMoreAssets

II.   ‘CuraTeIpsum’:Domes:c&South−SouthEMDEInvestment

III.   OriginalFormsofNorth−SouthandPublic&MDB−PFCoopera:on

IV.  EMDEInvestmentas‘ESG/SDGAc:on’and(Pension)Statesmen−CEOs

V.   ConcludingRemarks:BeyondFinancialEconomics...

.

I.SizeMa�ers:Pension‘Superpowers’CanShilMoreAssets

Source:WorldPensionsCouncil(WPC)research– ini:allypublishedinFrance(RevueAnalyseFinancière)andtheUK(PensionsAge)

Flagsizerepresen:ngna:onalpensionassets;therela:vesizeofUSandUKpensionsbeingactuallylargerthanrepresentedhere

V.ConcludingRemarks

Ø  Fiduciarycapitalism=pa:ence:“InvesCngshouldbemorelikewatchingpaintdryorwatchinggrassgrow.Ifyouwantexcitement,take$800andgotoVegas”PaulSamuelson

e.g.aNorthAmericanstate/localpensiontrustee(boardmember)toldtheauthor:“Wehaveadis2nctdefini2onof‘LongTerm’=weperceiveandprac2ceassetvalua2ondifferently.SomeWallStreetinvestmentbanksmaythinkweoverpay…They’vebeenprovenwrong:lookathigh-speedrailandairportassetsintheUK!”

Ø  Stablelawsareessen:al:PropertyrightsshouldbeperceivedassacredbythepublicsectorIncaseofexpropria]on,govt.havetocompensateinvestorsfairly&amicably≠EvoMorales

Ø  StrongjudiciarybranchindependentfrombothGov.andBig-Business:“AllourexperiencestellusthattheprocessofexpropriaCon,whichstartedwiththeriseofcapitalism,doesnotstop...onlylegalandpoliCcalinsCtuConsindependentofeconomicforcesandtheirautomaCsmcancontrolandcheckthemonstrouspotenCaliCesofthisprocess”HannahArendt

Ø  Beyondfinance:Pensioninvestorsmustbe(more)willingtoexperimentearlyon,traintrustees+hirecivilengineersandlegalexpertstocomplementtheworkoffinancialanalysts:“Manypensionfundslackthevision...orthewill...toincurthecostofbuildingstaffexperCsetoplaysuccessfullyinthisassetclass.Trusteesarenervousabouttrespassingtoofarfromwhattheythinktheyknowbest[bonds,listedstocks]....IunderstandtheiranxieCes...Isuggest,however,thatinfrastructureisanalmostperfectassetclassforlargepensionsfunds”MichaelNobrega,fmr.CEO,OMERS

Thankyouforyoura�en:on/Contacti

M.NicolasJ.Firzli,Stat.,LL.M.

Director-General,HeadofResearchEUCellphone:+(33)6.65.23.65.32.

Dir.Email:nic@worldpensions.org

Someofourpublically-availableresearchprimersareaccessibleon

h�ps://worldpensions.academia.edu/MNFirzli