A national harmonisation of the rules around infrastructure investment is sorely needed if more Australian super funds are to help build their own backyard, writes Middleton’s JIM BULLING. He is fresh from a bad experience trying to help a mid-sized super fund get set in the asset class.

The deficiencies of the infrastructure industry in its appeal to superannuation funds was starkly illustrated to me earlier this year when a client was looking to make a significant investment with a consortium in an attractive infrastructure project. The client was enthusiastic about the project and in preparing its bid paid a number of consultants to focus on various aspects of the due diligence required.

The first sign of a potential issue however was when the consortium’s organisers could provide none of the investors with clear details of their proposed participation in the deal, which included questions over exactly how much money each investor was going to contribute. While the rough big picture numbers could be estimated, the investors had no solid financials on which to justify their participation in the due diligence process for the investment.

The bottom line was that the trustee of the superannuation fund could not justify to members spending a large sum of money on the preparation phase alone. The irony was that if the trustee had completed the infrastructure deal, the fund would have achieved a better return than it has subsequently experienced by continuing with its established investment strategy in more conventional asset classes.

So how do we ensure these opportunities to invest in infrastructure aren’t lost in the future?

One of the mandated considerations for any super fund is liquidity, that is, they must match their investment strategy to their liquidity obligations, and this is difficult to be certain of when investing in infrastructure. In a wholesale unit trust, for example, super fund trustees can get a clearer understanding of liquidity. These statutory requirements applicable to super funds make them a little different to other institutional investors. Had this super fund client progressed the deal, it would have had to confront further issues about transparency and accountability.

Super funds need to report performance on an ongoing basis, which is critical in a competitive environment because members have the option of moving funds if they are unhappy about performance. Infrastructure in this regard is difficult to report, as up-to-date valuations are difficult to identify. Again this may make an investment by a super fund in a wholesale unit trust more attractive than an investment in infrastructure. There are some superannuation funds which are willing to take these issues on because they are better able to assess some of the unique risks involved in infrastructure.

For example the MTAA super fund has done extremely well in investing about 30 per cent of its funds under management in infrastructure (according to Rainmaker data). However, in order for other superannuation funds to increase their exposure to infrastructure some other issues around the bidding process will need reform.

The major disincentive for super funds and especially those other than the largest industry fund behemoths is the cost equation for competing, bidding, negotiating, and entering a contract. There is no standard deal structure for investment in infrastructure and each State has developed different templates when it comes to documentation of these sorts of transactions with some States having multiple sets of documents depending on the types of asset and which lawyers are acting on the deal.

State and Federal governments need to agree on some standards for infrastructure much like what has happened in the UK so that the costs of bidding are kept to a minimum and so that more superannuation funds are encouraged to become involved in this emerging and important new asset class.

Another major issue is that for infrastructure to be taken seriously by the superannuation industry, there must be a pipeline of projects coming through. Currently the opportunities are too haphazard and ad hoc and the history of investment contains too many disappointments. For those projects that have come online, there have been a small percentage of failures such as the Cross City Tunnel, which always sit uncomfortably in the background when a new deal is being considered.

If the infrastructure industry becomes more professional and commercial, it is more likely to succeed. Another limiting factor for investors in infrastructure is the number of assets that are still being regulated by government. Regulatory risk is still a work in progress. When governments control the pricing for economic assets such as roads, energy and power, this impacts returns and acts as a powerful disincentive for super fund investment.

But there’s some good news on the horizon.

It has been estimated that about 75 per cent of infrastructure is the responsibility of the States (such as ports, roads, and schools), and 25 per cent is the responsibility of the Federal Government. It is well known that each of the States have developed their own idiosyncrasies in the bidding processes which adds additional time and money for potential investors.

However, the new government has announced some important initiatives including singling out a Minister for Infrastructure, who in turn has established Infrastructure Australia (IA), which is charged with providing leadership within the industry. IA is currently undertaking an infrastructure audit and by March next year will determine a list of infrastructure priorities. Infrastructure Australia already has a Federal Government commitment of $20 billion. When it comes to superannuation funds, it is interesting to note that the total amount currently invested in infrastructure is not accurately known because a lot of money is invested indirectly into projects and is therefore hard to trace.

Conventional wisdom suggests that 3 per cent of Australian superannuation fund investment is in infrastructure, while it is believed that the experience overseas of super fund investment is closer to 5 per cent, a difference that suggests a significant under-investment in this country.

Broad numbers indicate that the average annual level of investment in infrastructure in Australia in order to produce GDP growth similar to what we have experienced in the past should be in the range of $15-25 billion per year, which needs to come from a mix of state, federal and private funds, of which super funds could make a significant contribution.

An audit may identify that we’re way behind, but one thing is certain: we’re not way ahead. The Federal Government’s $20 billion stretched out over five years is only $4 billion a year, leaving $11-$21 billion per year to come from the States or private funds. It is difficult but not impossible for super funds to play a meaningful role, but the industry has to get a lot smarter and more efficient.

Federal initiatives look okay on paper, but could be rendered meaningless if politics plays too much of a role. Certainly if some of the big picture issues identified here were addressed, perhaps the experience my client had would not have ended up as it did. When super funds currently report to APRA, investment in infrastructure is still listed in the ‘other’ column in industry statistics.

To encourage new money into the infrastructure industry, we need to win super fund investors over with a confident, professional, evidence-based approach. If this happens, a new asset class could emerge on the books of super funds and be made available to a wider group of investors.

Jim Bulling is a senior partner at Middletons, based in the firm’s Melbourne office and heading the banking and financial services division of the business. Working with superannuation and managed funds, Bulling specialises in matters concerning compliance, governance and disclosure.

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