Infrastructure and Valuations

Some superannuation funds have achieved above average returns in recent years, partly due to a very high exposure to infrastructure assets.

These are typically big-ticket assets such as airports or tollways, which are not listed on the stock market. Hence, they do not suffer daily fluctuations in share price.

The trade-off is liquidity. Obviously, it is not possible to sell a large asset overnight. In some cases, it may take years and may even require the vendor to reduce the asking price to find a buyer.

However, the Chief Investment Officer of one such fund believes that the younger demographic of the funds membership means they have a high tolerance for illiquidity?? In other words, it is unlikely they would ever need to sell in a hurry.

Strangely enough, our experience has always been that investors have a high tolerance for illiquidity until they need the money or are scared! The GFC is a now forgotten case in point.

The key point though, is that some managers are claiming that these illiquid assets produce higher returns due to a so-called “illiquidity premium.”

One benefit from a superannuation manager’s point of view is that in the event of a stock market downturn there will be no immediate downward revaluation of the illiquid assets, unlike the brutal punishment suffered by companies listed on the stock exchange. This helps to retain members and lessens those pesky queries by concerned investors. As a result, more and more funds are climbing over each other to buy these assets.

Warren Buffett, the renowned and very wealthy investor, made the famous quote: “Price is what you pay, value is what you get”.

We see this competition for scarce infrastructure assets as no different to overenthusiastic bidders at an auction. The eventual price paid may exceed all expectations. However, who will buy from you at the same or higher price in the short term? Only someone who recognises the value.

Recently a conglomerate of super funds purchased a US oil pipeline business for almost $15 billion. It is believed to be the largest cross-border acquisition by an Australian business since BHP made the disastrous purchase of Petrohawk in 2011. It is a huge business with over 10,000 km of pipeline and a network of storage facilities and sea terminals. Therefore, it clearly qualifies to be described as an infrastructure asset.

What is really interesting though, is that this business/infrastructure asset was previously listed on the US Stock Exchange. Even more interesting, the purchase price was US $41.50 per share. Yet on the day of the announcement, the best an existing investor could obtain upon sale on the Stock Exchange was US $32.55! In other words, in order to gain 100% control of this asset, the funds paid a premium of 27.5% above what the rest of the world believed that asset was worth!

If there ever was such a thing as an illiquidity premium, we believe it was well and truly paid for upfront!

As mentioned earlier, the stock market can be brutal at times with prices dropping sharply, for individual companies, if sentiment or performance sours. In our view, that also makes it a very honest market as it reflects the collective opinions of a very large number of potential purchasers and sellers. If you pay 27.5% above that collective wisdom, we believe you will need a lot of things to go right to achieve value in excess of price.

Transparency is an important criteria when we are assessing investments.  Infrastructure, Direct Property and Private Equity are all very valid investment classes.  However, our concerns in the current superannuation industry are that as the proportion of these assets grow in default funds:

  • How are they being valued on the balance sheet of super funds?
  • If a fund has purchased a listed company at significant premium, is it being valued at the purchase price or at the lower market price?
  • What level of total assets of the fund are illiquid?
  • Why are directly owned infrastructure and property assets being classified as defensive assets in asset allocations of large “Balanced” Funds?

At the end of the day, everything has a risk. Paying more money than the rest of the world believes is a fair price for an asset seems like a good way to transfer a lot of Australian superannuation savings into the hands of smart US infrastructure salesmen.