How PGGM's direct approach has helped shape the market

In this latest interview, PGGM's new head of infrastructure, Erik Van de Brake, talks about how successful the direct investing strategy has been and how the pension fund will continue to expand in the asset class.

PGGM is one of a handful of European pension funds at the forefront of the direct investing revolution. While that innovation has been dominated by Canadian pension and Australian superannuation funds, a number of European institutions are also carving out name for themselves with similar types of investments.

Last year PGGM’s direct investing approach reached a new level of sophistication. And two deals in particular have epitomised how far the Dutch pension fund giant has come since it started to invest directly, some eight years ago.

The first of the transactions to grab attention was a 20.3% acquisition of Pennsylvania-based Duquesne Light Holdings. The second, a joint venture with American Tower Corporation (ATC Europe, which includes the German assets of ATC). The new JV then acquired French telecom towers business FPS Towers from Antin Infrastructure for EUR 697m.

To be able to make such direct investments has required significant resources and the development of origination and asset management skills and knowledge over a long period. Most pension funds lack that kind of capability, although many would like to have it. So how and why has PGGM managed to do it?
“We have much longer investment horizons [than GP-managed funds],” says PGGM head of infrastructure Erik van de Brake. “And now returns are lower than two or three years ago, the cost element has become even more important.”
Van de Brake says there are three core reasons why a direct approach became the focus of PGGM’s investment strategy. There is the fees-related cost element and gaining more control of decision making at the asset level. It was also important for PGGM, as a long-term investor, that it was able to match its liabilities in a way that seven-to-ten year GP-managed funds simply could not deliver.

That view chimes with the reasons given by former PGGM head, Henk Huizing, when PGGM first embarked on its direct investing strategy. At that point, six years ago, in an interview with InfraNews, Huizing suggested that the high cost of GP-managed fund fees and a lack of control over asset selection were central to the decision to take the direct route. Before Huizing initiated PGGM’s direct investment strategy, the pension fund investor had focused mainly on fund of funds, and so had extra fees and little control over asset selection.

Huizing was succeeded in 2015 by Frank Roeters van Lennep, who in turn gave way to Erik van de Brake last November. But it is not just the leadership at PGGM that has changed. Since PGGM began its direct investment journey, infrastructure markets have also altered considerably, meaning PGGM has had to evolve to meet new investment environments, and is why the saving element of direct investing has become even more important.

Portfolio growth
The pressure on returns in today’s market clearly vindicates PGGM’s direct investment approach. The growth in PGGM’s direct investment portfolio shows that the Dutch pension fund manager has also developed a sophisticated and successful approach to origination.

To put that into perspective, PGGM’s infrastructure portfolio has grown from EUR 750m in 2008 to EUR 8bn today. At the same time, its team has grown from four to 25. Since 2010, PGGM has made 15 direct investments in Europe and North America. It has also entered into a number of joint ventures with other financial investors and strategics, including BAM PPP, Globalvia, American Tower Corporation and UPP (PGGM’s UK-based student accommodation business).

Joint ventures
Joint ventures have been a major part of PGGM’s direct investment strategy and are one of the ways in which pension funds can gain greater control of their infrastructure investments. It is also a way for them to invest in riskier greenfield deals, as the strategic investors they can partner with have significant experience of taking development and construction risk.

PGGM’s first joint venture was with BAM PPP. The JV, BAMPPP PGGM Infrastructure Coöperatie UA, was formed in 2011 and since then has invested in 28 operational and greenfield PPP projects across Europe. That is a significant number and helps to highlight the level of infrastructure exposure PGGM is able to achieve through its JV strategy.
“Joint ventures have worked out very well for us,” says van de Brake. “They offer us a long-term investment perspective with parties that complement what we bring.”

What PGGM brings is major financial clout. To highlight this, as of 2015, overall PGGM has EUR 183.3bn of invested assets across all of its portfolios.

It is not only PGGM’s joint venture with BAM PPP that allows the pension fund manager to invest in greenfield risk. It also has the same approach with its other JVs. But when investing on its own, PGGM tends to take a more cautious approach.

“We are much happier investing in operating assets but might also step in during construction,” says van de Brake. “We don’t get involved in the development phase. But the large companies we are invested in might develop projects themselves.

“However, they are mixed into a larger portfolio, so the risks remain manageable.”

It’s good to be able to compare the US with Europe...

One of those large infrastructure companies is Globalvia. PGGM, along with OPTrust, invested EUR 400m into the Spanish developer in 2012. And last year PGGM and OPTrust, together with USS, acquired the whole of Globalvia. InfraNews reported at the time that EUR 166m was paid initially, with a further EUR 254m due in 2017.

Globalvia owns several toll roads and rail concessions in Europe, especially in Spain, but in recent years has been expanding its operations to both North and Latin America. Last October, for example, it acquired the Pocahontas Parkway in Virginia for around USD 600m.

Van de Brake points out that developing successful joint ventures is a long process. He adds that crucial to the success of such a strategy is ensuring that there is a continual dialogue around each party’s objectives, expectations and restrictions.
“We are dedicated to invest substantial time and effort in building trust and getting to know our (prospective) partners,” adds Van de Brake. “Partnerships cannot be established overnight and the BAM and ATC joint ventures are great examples of that.”

JVs and investments in other companies have also allowed PGGM to increase its global footprint.

For example, the ownership of Globalvia and direct investments like Duquesne Light Holdings, have given PGGM many more opportunities to invest outside of its core European markets and in North and Latin American deals.

Van de Brake confirms that the US has become more important to PGGM in recent years, and that as a result, the pension fund manager has access to a much wider range of potential deals.

“It’s good to be able to compare the US with Europe to see where the most interesting opportunities are," he says, adding: “We’re looking to see what the new US government will do. But there are good opportunities in utilities, renewables and transportation in the US. So we intend to remain active in those markets.”

Those three sectors along with PPPs, and telecoms have formed the bulk of PGGM’s investments over the past six years. The only two sectors that have tended to be neglected by the pension fund investor are ports and airports. Van de Brake says this is simply due to the fact that, historically, PGGM has been less successful at bidding for such assets but that there is nothing intrinsic about ports and airports that puts them off.

“We’ve looked at a couple of opportunities in those sectors in the past two years,” says Van de Brake. “But were either unsuccessful or decided not to pursue them.”

The asset management learning curve
Traditionally, one of the major stumbling blocks to direct investing by pension funds is the lack of expertise and resources they tend to have for asset management. For a long time this has been one of the major advantages that GP managed funds have tended to have in the infrastructure space. But in recent years, pension funds have been spending more money on and building up their skill sets in infrastructure.

And while much of PGGM’s energy over the past six years has been on growing its asset base, it is now seeking to spend more of its efforts on asset management. Van de Brake says that as a result, PGGM is having to devote time and resources to better understand the assets it owns.

“We’re learning fast,” he says. “We are refinancing and seeking to grow our current assets.”

As a next step, Van de Brake says that PGGM intends to hire more people to its asset management team.

But at the same time it will maintain a relatively cautious approach to the kinds of infrastructure it will invest in.

So, for example, an expanded asset management team would avoid some of the more complex kinds of “value-add” infrastructure deals, as well as markets outside of Europe and North America. This, of course, leaves these areas open to GPs and potentially PGGM’s investment in funds.

We invest in Asia through GPs. We’ve made some co-investments there, too.

But even a more cautious approach to asset management has its challenges. One of these, says Van de Brake, is when other partners or shareholders in an asset have shorter-term investment objectives relative to PGGM’s longer term approach. In order to try to mitigate this kind of misalignment of interests, Van de Brake says that PGGM tries to make it clear to the management teams of its portfolio companies that it is seeking long-term value, rather than short-term returns.

That means that PGGM tends to hold onto its investments. But there have been a couple of exceptions. The largest of which was the sale of Eversholt Rail. PGGM owned 14.26% of the the UK Rosco. The other owners were Star Capital Partners, Morgan Stanley Infrastructure Partners and 3i Infrastructure. Eversholt was sold to CKI in 2015 for an equity value of GBP 1.1bn and an enterprise value of GBP 2.5bn, which represented a 3.4x money multiple for the sellers.
But while PGGM focuses on long-term value, there are still some instances where it may still seek to employ GP-managed funds for some investments. However, PGGM’s focus on direct investment has meant that its use of infrastructure funds has decreased and will continue to do so as it develops its direct investing experience. But funds will not disappear completely from PGGM’s radar. “We will continue to look at this type of investment for specific areas, but as a percentage of our portfolio, they will continue to diminish,” says Van de Brake.
The areas Van de Brake is talking about are countries in which PGGM has little experience but are offering up important opportunities. “We invest in Asia through GPs,” says van de Brake. “We’ve made some co-investments there, too.”

“We are interested in investing in that region but that moves us away from our direct investment approach, because direct investments in Asia are beyond our mandate. “Whether we will make new investments in Asia is something we will review periodically, or if an opportunity pops up, whether we take it.”

To date, PGGM has made a USD 400m commitment to the USD 2.3bn Macquarie Asia Infrastructure Fund, which has, so far, invested in assets in Australia, India, Japan, Singapore and South Korea. The 10-year fund has a target net IRR of 14-16% with an average annual yield of 5-7%. The Dutch pension fund manager has also invested in USD 870m Macquarie Greater China Infrastructure Fund.

Competition
But at the moment a focus on driving value from its existing portfolio appears a shrewd strategy, particularly given the intense competition for assets, which have forced down returns in some parts of the asset class. Paradoxically, the growth in competition has been driven, in part, by greater numbers of institutional investors such as PGGM seeking to invest directly in infrastructure.
And greater competition has had a major effect on how infrastructure markets have developed. For example, many GP managers have moved out of the “core” infrastructure space, towards more “value-add” and “opportunistic” deals. At the same time, the very definitions of what constitutes infrastructure are changing. But it’s not just GP managers that have had to adapt.

The increase in competition has also encouraged PGGM to reorganise it’s approach to origination.

“We now have teams that specialise in specific industry areas, which will give us a better understanding of the market and where the opportunities lie,” he says. “As the market gets more competitive, we need to work that bit harder.”

But increasing competition for assets is not the only problem facing investors such as PGGM. Political risk following Brexit, the Italian referendum and the election of Donald Trump as US president, is now much higher up on the agenda in Europe and North America.

“Brexit was the most important event in Europe last year,” says Van de Brake. “And we look at political risk and we’ve been waiting to see what effect it has on the UK market.

“Even though political and regulatory risk are higher up the risk agenda, they are not materially effecting our strategy. We take the view that if an asset is essential to society and operated by the private sector, then it is in the government’s interest to make it work and investors get a decent return.”

Outlook
Despite the political upheaval of the past six months, Van de Brake believes that interest in the asset class will grow over the next year, which he says, will lead to even more competition for assets.

Even so, Van de Brake thinks that is an atmosphere in which PGGM can still thrive by making new acquisitions and developing its internal expertise.

With such an approach, Van de Brake believes that PGGM will continue to be among the trend setters among European pension fund direct investors. And if the last eight years are anything to go by, then PGGM is likely to remain among the forerunners of pension fund direct investing. It will be interesting to see if many others follow and how GP managers react.