AustralianSuper's growth putting pressure on infrastructure firm IFM

The deep alignment of interests that IFM Investors Pty Ltd. has long maintained it shares with its superannuation fund owners might be fraying.

The Melbourne, Australia-based infrastructure investment heavyweight on April 23 found itself outbid for a marquee Brisbane toll road property by a consortium that included IFM's biggest owner-client: the A$75 billion (US$69.3 billion) industry fund AustralianSuper, also of Melbourne.

That intersection of collaboration and competition for IFM and AustralianSuper is one result of continuing efforts by superannuation funds to squeeze scale benefits from the rapid growth of their investment portfolios, fueled by mandatory annual employer contributions of more than 9% of employees' salaries.

Those efforts — focused on building in-house management teams that can take greater control of investments in unlisted assets such as real estate and infrastructure — should leave IFM facing growing pressure to diversify beyond a business model anchored on commingled fund vehicles, industry observers predict.

In a recent interview, Brett Himbury, IFM's chief executive, conceded the need to evolve to serve clients looking to put more money to work in infrastructure at lower fees, while becoming more involved in the deal origination and management process as well.

But he argued that evolution is well underway. A case in point: last year's winning A$5.1 billion bid by an IFM-led consortium for a 99-year lease on two ports in the state of New South Wales.

For that deal, Mr. Himbury said, AustralianSuper, in addition to making an investment in an IFM-sponsored commingled pool, took a direct partnership stake in the consortium. Three other Melbourne-based superannuation funds with a combined 25% stake in IFM — A$26 billion Cbus, A$27 billion HESTA and A$15 billion HOSTPLUS — made co-investments as well as pooled investments.

For the just-concluded Brisbane auction, AustralianSuper — IFM's largest shareholder with a 50% stake, as well as its largest client, accounting for more than A$18 billion of the firm's A$52 billion in assets under management — committed 25% of the winning A$7.06 billion bid.

Other consortium members were Transurban Group Ltd., with a 62.5% stake, and Tawreed Investments Ltd., a unit of the US$627 billion Abu Dhabi Investment Authority, with a 12.5% share.

(Well over half of the more than A$18 billion IFM manages for AustralianSuper is in IFM's non-infrastructure business segments, including private equity, indexed listed equities and cash.)

In a recent interview, Mark Delaney, AustralianSuper's chief investment officer, noted that the two board seats AustralianSuper gets for its sizable investment in Queensland Motorways leave the fund with a “stronger governance position” than a smaller equity holding would have offered.

The internal management effort AustralianSuper launched in late 2012 has brought between 5% and 10% of the fund's fast-growing portfolio in-house, a proportion that should rise to roughly a third within five years, said Mr. Delaney. More liquid asset classes have been the first to be brought in-house; the fund will retain its existing external mandates for unlisted asset classes such as infrastructure for now, while using net new cash flows to make direct investments in the future, he said.

The prospect that IFM's other client-owners will follow a similar path as their portfolios likely double in size in the coming five or six years could leave the firm facing a trickier competitive environment in an Australian market that's been an epicenter of global infrastructure investment.

In an infrastructure market that typically sees more demand than attractive investment opportunities, if this kind of fragmentation results in auctions where “you're basically bidding against yourself,” that could be a “lose-lose” situation, noted Daniel Celeghin, Hong Kong-based partner and head of Asia Pacific with money manager strategic consultant Casey, Quirk & Associates.

Whatever the implications, some observers call the latest evolution in IFM's ties with its institutional owners inevitable.

“This was bound to happen” as the growth in scale and resources deployed by superannuation funds leaves them less and less willing to be passive providers of capital, noted Sam Sicilia, chief investment officer of A$15 billion Melbourne-based superannuation fund HOSTPLUS.

As the country's biggest industry fund, AustralianSuper is first off the block, noted Mr. Sicilia. But “when HOSTPLUS gets to that size,” it might pursue partnership stakes in consortiums as well, he said. In a recent interview, he predicted HOSTPLUS' investment portfolio could triple over the coming five to six years.

Cbus, which focuses on construction industry employees, is likely to see its portfolio expand to more than A$50 billion within five years, noted Kristian Fok, the Melbourne-based fund's executive manager-investment strategy.

“As you get bigger, you need to have a different way of allocating capital, rather than just relying on a pooled fund where there may be a queue that you have to wait for,” said Mr. Fok. For last year's New South Wales ports bid, Cbus invested in both a pooled IFM fund and a co-finance deal as well, “but as we get bigger, that model will probably be refined over time,” he added.

Trends like that in Australia's fast-growing retirement market will force IFM to provide pooled investment vehicles for some, advice for others, as well as co-finance and consortium partnership opportunities, said Mr. Sicilia, who predicted IFM “will make the right choice, because the alternative is extinction.”

For now, growing interest in infrastructure among institutional investors around the world is making the business environment appear more feast than famine.

IFM has enjoyed particular success over the past two years, adding more than 30 big institutional clients, including a number from Europe; Canada; the U.S., where five of the 10 largest public pension funds have now awarded the firm mandates; and “our first investors from Japan ... and Malaysia,” said Mr. Himbury. IFM has 148 clients, he said.

While the firm remains focused on infrastructure equity, “we're seeing an enormous amount of interest in infrastructure debt” now as well, particularly from Northern Hemisphere-based defined benefit plans, with their relatively high allocations to fixed income and their greater “propensity and capacity to take on illiquidity risk,” he noted.

Many of those clients “are looking at slicing a sector of their fixed income” and adding infrastructure debt, even as that flow of capital, and a recent rebound in banks' willingness to lend to infrastructure projects, has halved the yield premium over government debt offered to between 150 and 250 basis points, Mr. Himbury said.

For now, the biggest U.S. pension funds appear comfortable investing in pooled vehicles, but in time, their desire to get more involved is likely to evolve, he said.

At the end of the day, however, making multibillion-dollar investments in long-term infrastructure projects will require skills and expertise that not that many institutional investors will likely choose to develop internally, leaving working together with managers like IFM to tweak the current business model a preferred option, Mr. Himbury said.

Pooled vehicles should remain a centerpiece of that changing landscape, he predicted.

“How do we, IFM, evolve to insure that we continue to protect all of the interests in a pool, yet at the same time give our investors a greater capacity to deploy (more capital), a greater involvement in the deal origination and management process and improved scale benefits? I reckon we can do that,” said Mr. Himbury.

Still, his confidence appeared to rest, in part, on a conviction that a market where pooled vehicles become marginalized could have considerable downsides.

“Let's not get to the stage where we're all competing with each other, and disaggregating,” he said, because in a market with only a small number of big deals in play each year, “you don't want to have a fragmented capability in that sense.”

The annualized return of 12.3% IFM's pooled infrastructure fund has delivered over the past 19 years through March 31, 2014, together with the strong records of competitors' pooled funds, should give those vehicles a good claim to continued consideration from institutional investors, he said.

Asked if IFM is pursuing offshore clients because its local owner-clients are moving away from pooled vehicles, Mr. Himbury said it's more a matter of pursuing greater scale that can give IFM “the capacity to get to negotiating tables that others aren't at,” including “bilateral situations ... where you can mitigate the shootout that's often inherent in an auction process.”