In a recent meeting with the Future Fund we discussed how to achieve greater impact in improving the value proposition for the end saver. In the spirit of collaboration Future Fund gave us permission to write up a couple of case studies describing how they have sought to increase the flow of value to their fund. This case study concerns infrastructure.
Approximately six years ago there was an opportunity to acquire large stakes in two Australian airports. The Future Fund were offered these stakes by several managers, all of whom offered them wrapped in an illiquid vehicle that locked in the manager, effectively forever. The CIO’s previous experience with managing airports such as London’s Gatwick made it clear that these were very attractive assets with significant value creation potential – but too much of that value would be captured by the manager for too little effort (more below).
Future Fund consider themselves genuine long-term investors, which requires the ability to sell fully-valued assets as well as to buy under-valued assets. An illiquid structure would prevent them from being able to sell at the point of their choosing, and so a different solution was required.
The Future Fund decided to buy the assets directly, and drew up contingency plans to hire an internal team to manage the assets. Again, this option was less than ideal as it would present an HR headache at the point of selling the assets. However, it showed them how much it would cost them to manage the assets internally. They then put the management of the assets out to tender.
The Future Fund required bids to demonstrate expertise in retail, car parking, capital investment programs and land development. Quite often the manager had the expertise, but sitting in a separate real estate silo (or siloes) – so they were effectively engaged in silo busting.
Given the known cost of managing internally, the Future Fund asked for a fixed fee basis with full transparency, including the extent of profit margin.
They also asked for the flexibility to terminate the contract at any time, allowing them to sell the assets if valuations rose rapidly – but, they recognised the upfront implementation costs and so offered protection against losses in the event of early termination.
The final element was a performance fee related to the fundamental performance of the assets, not their valuation (after all the Future Fund had decided the entry price, and would control the decision over the exit price). In our minds this is akin to the origin of smart beta / factors – why pay a hedge fund 2+20 for systematic returns that could be captured for 20 basis points (historic pricing). So any returns attributable to declining bond yields would not be compensated as if generated by manager skill. So a performance fee is instead payable if various key performance indicators increase. These include:
- Retail spend rates per passenger
- Revenue from the property bank over time
- EBITDA margins
- Capital programs delivered under budget and on time.
Why is this important?
It turned out that one of the successful managers was already managing the assets. Only now they were bringing a new and focussed team to the management of the assets, they were incentivised to create real fundamental value, and Future Fund were paying a much lower base fee – and one that didn’t credit the manager with changing economic conditions. In short the end saver, in this case citizens of Australia, are receiving significantly more value from these assets.
A further personal musing: this case study shows a disruption of the traditional asset management function of combining transactions and ongoing management. Can we imagine a transfer of this concept to listed equities (and potentially other asset classes)? Here the asset owner would use their own valuation tools to decide on the buying and selling of individual equities, and would use the asset manager to, well, manage the assets ie vote and engage. I am not suggesting this is currently practical, but it would be highly disruptive to the current value chain.