Leo de Bever, one of the key decision-makers in a co-investment deal to buy almost half of Birmingham International Airport and now CEO of AIMCo, tells Simon Mumme about the future scope and necessary resources, relationships and disciplines required for co-investment deals.
When the Birmingham Airport deal went through, de Bever was chief investment officer of an Australian state government-owned asset manager, the $A32 billion Victorian Funds Management Corporation (VFMC). He drew on contacts from his old employer, the C$87.4 billion Ontario Teachers’ Pension Plan (Teachers’), to spearhead the transaction, which saw VFMC and Teachers’ own 48.25 per cent of the airport in a 40/60 split, respectively. The funds paid $A1 billion for the asset.
The deal made strategic sense from the outset. Both funds held similar return expectations from the investment (at the lower spectrum of equity returns, but with less risk) and the resources to manage it, an aligned investment timeframe, and an interest in driving down the costs of infrastructure investment.
They also had the right connection: a couple of years before joining VFMC, de Bever had ended a 10-year term as Teachers’ senior vice-president of research and economics, and was responsible for its long-term investment strategy, risk management and real assets. During his tenure at the Canadian fund, he hired and trained the infrastructure team that he later worked with on the Birmingham deal.
“If you know the players it’s easier to achieve an alignment in terms of what you want as an investment horizon and in return expectations,” de Bever says.
“All of these deals depend very heavily on personalities.”
The unlisted assets that suit co-investment by pension funds are usually private equity, infrastructure and timber, he says. Essentially, the deals are outcomes of “like-minded investors that get together and put money on the table”.
He expects more co-investments between funds as they continue to build scale in the long-term, develop more internal capabilities and expertise for investing in illiquid assets.
“Last time around, pension funds were too immature at investing in private equity and infrastructure to do this on a big scale. In the next wave, you will see combinations of European pension funds and North American pension funds banding together because the economies of scale are so compelling.”
“The only thing – 10 years ago, five years ago – that they didn’t have, was expertise.”
For VFMC and Teachers’, the Birmingham Airport transaction was straightforward: the asset was “simple” and already being competently run, the investors’ varied perspectives were aligned, and they had candidates for the two seats on the airport’s board they were entitled to – one to contribute to the operations of the airport and another to watch the investment on VFMC and Teachers’ behalf.
The two funds formed a special purpose corporation, Airport Group Investments Limited, to invest in the company. This new entity then became a long-term partner with the District Councils in the West Midlands of England, which owned a 49 per cent stake. The remaining 2.75 per cent is owned by airport staff in an employee-share trust.
These existing shareholders were initially uncomfortable with the funds’ advance on Birmingham Airport, fearing they would bail out and not be long-term asset owners. “They tested us out on that one,â€ de Bever says, before allowing that an Australian superannuation fund, the $A23 billion UniSuper, was also a party to the deal in its early days before withdrawing as discussions gained momentum.
In direct co-investments, trust among the parties is as important as aligned views and adequate resourcing.
“While you’re doing the deal it’s incredibly important that people are on the same wavelength,” de Bever says. “Negotiations tend to go through the night, and decisions can happen at 3.00 m.”
Provisions were embedded in the contract, to mitigate any subsequent disputes or to arrange an early exit. These can become more complex as the number of co-investors grows: funds should assume that a greater number of investors will create a more complicated deal.
“You can’t have too many partners. If you have more than two or three, the likelihood of views becoming a problem starts to increase.”
The partners must be well-resourced in order to perform analysis of the asset, monitor it through its lifetime, and investigate future deals. When the stake in Birmingham Airport was acquired, VFMC had an infrastructure team of six; Teachers’ had nearly five-times that number.
“The need to supervise [the asset] requires a bigger staff – All the energy just can’t go into buying this stuff – then you have a portfolio that you have to manage.
de Bever says funds need to have between US$50-100 billion under management to command enough scale to build such capabilities, particularly since it was usually necessary to pay commercial rates for good talent.
It should also be noted that when funds collaborate, the resources committed to the deal at hand are strengthened as two teams combine to do the work.
But some obligations arising from direct ownership of an asset, such as operational skills for an airport, will probably need to be outsourced.
“Pension funds don’t have a natural operations expertise. We’re not in the widget business, but someone else might be. We have the capital, and an understanding of business, but not enough to run it.”
By investing directly in infrastructure, pension funds can save about 10 per cent of the gross return that would otherwise be forfeited if they entered an infrastructure fund, de Bever says. But for funds with insufficient resources to competently acquire and manage a large, unlisted asset, managers can provide valuable analysis.
The model for direct pension fund investment in acquiring large unlisted assets is evolving as funds outnumber managers in the consortiums that bid for large assets.
An example of this is the group of investors behind the merger transaction between the US company Puget Energy by Puget Holdings, a collection of investors, for US$7.4 billion. The investors comprising Puget Holdings are Macquarie Group, the Canadian Pension Plan Investment Board, British Columbia Investment Management Corporation and AIMCo. The acquisition was finalised in February.
“There is a role for infrastructure managers to provide expertise and analysis. You can see the model evolving,” de Bever says.
More recently, AIMCo has discussed co-investing with pension funds to access absolute return managers and negotiate lower fees.
In the infrastructure sector, however, the opportunities coming on stream now are not often priced to reflect the global economic downturn and still demand 2007-08 costs.
But roads, airports, and energy and water infrastructure still need to be built and maintained. de Bever thinks the deals on offer today are too expensive, compared to when he first began investing in the market a decade ago, when it was less efficient and good opportunities arose more frequently.
The pricing of all alternative assets, and fees paid to managers, will be debated for some time as many investors re-examine what they have bought, and their reasons for investing in them.
“One or two years ago everybody was enamoured with alternatives. People forgot that it’s not the asset that you should be attracted to, but what the asset provides.”
What do you think are the obstacles to co-investment?