Market Commentary
The S&P had its strongest first quarter advance since 1998, buoyed by improving domestic fundamentals, notably improving employment, manufacturing data & consumer sentiment. Risk assets had a broad based rally, spurred on by the positive European policy response in the form of LTRO 1 in December and LTRO 2 in February. The market shrugged off S&P and Fitch European Sovereign & Bank credit rating downgrades during
February, which were largely priced in. The Fed also communicated a “lower for longer” interest rate environment to the end of 2014.

Infra Funding

• Following the S&P downgrade of Spain & Portugal, Red Electrica was downgraded from AA- to A+ and EDP to BB+, and Enagas from AA- to A+.
• Terna issued a 5yr bond for EUR 1.25b for 4.125% (257bps over midswap)
• Transurban raised CAD250m of maple bonds, Canadian dollar denominated bonds sold in Canada, the largest issuer by an Australian non-financial issuer. The bonds paid a coupon of 3.368% to yield 170bps above 2018 Canadian govt bonds
• Peru government said it plans to invest USD$11.1b over the next 5years in improving highway infrastructure, which would include 7270km of road. USD$3.7b will be invested in PPPs

Infra M&A

• Spain all together ditched a plan to privatise Madrid & Barcelona airports (aiming to raise USD$6.9bn), and intends on coming up with a new management model.
• E.ON, the large German integrated utility, entered into a strategic partnership with MPX in Brazil. Under the deal, E.ON will acquire 10% stake in MPX and form a JV for coal power stations and project pipeline.
• Enel placed a 5.1% stake in Terna, raising EUR 281m
• Abertis agreed to purchase Telefonica’s 13.23% stake in Hispasat (Spanish satellite operator) for €124m in cash. The acquisition price implies a 2012E EV/EBITDA of 7.8x and the company is indicating an estimated equity IRR of 13%
• Cosan, a Brazilian ethanol, food, motor lubricants, agricultural land company, and client to ALL (a Brazilian Railway) agreed to buy 49% in the holding vehicle that controls ALL’s voting rights. This was an outright purchase of 5.67% of the company, value d at R$896m or a large 100% premium to the last closing price.
• CP2 sold 8% of its 12.5% Transurban stake for AUD631m

Infra Regulation

• The US Dept of State has rejected the Keystone XL pipeline while allowing TransCanada to re-file its application once re-routing in Nebraska is complete
• The AEMC released a directions paper providing initial views on the AER proposed changes to the rule governing utility regulation in Australia
• Melbourne Airport, partly owned by AMP, Hastings Funds Management and the Future Fund, has released plans for a new terminal and improvements to clogged access roads as part of a AUD$300m overhaul. The centrepiece of this first stage is a new 35,000-square-metre domestic terminal capable of handling 20 million passengers a year.
• Speculation in the UK that the government is considering privatising roads

Portfolio Commentary
In the first quarter of 2012 RARE (+3.81%) outperformed its benchmark (+1.17%) and underperformed the UBS Global Infrastructure & Utility 50/50 Index (+5.45%).

Over the quarter, Electric (+158bps) and Airport (+83bps) outperformed, whilst Communications (-2bps) and Toll Road (+4bps) were the smallest contributors to performance. By region, Asia/Pacific (+156bps) and UK/Europe (+84bps) were the largest contributors, whilst Central/South America (-13bps) detracted from performance.

In stock terms, Companhia Energetica de Minas Gerais (Central South America Developing, Electricity) +80bps, Spark Infrastructure (Asia/Pacific, Electricity) +46bps and DP World (Middle East Developing, Seaport) +39bps were the largest contributors to performance. TransCanada (North America, )-15bps, Southern Co (North America, Electricity) -13bps and OHL Mexico (Central/South America, Toll Road) -13bps were the largest detractors.

We continue to look for companies with fundamental long term value, with strong balance sheets, strong management and supportive regulatory environments or long term contracts that help to underpin revenues, cashflow and dividends.

1. Transurban Group (TCL): Mkt Cap AU$7.5b
2. TransCanada (TRP): Market Capitalisation US$60.4b       
3. Sydney Airports (SYD): Market Capitalisation A$5.0b
4. National Grid PLC (NG/ LN): Market Capitalisation US$34.2b
5. American Water Works (AWK US): Market Capitalisation US$5.1m
6. Spark Infrastructure (SKI AU): Market Capitalisation A$1.7b
7. Northeast Utilities (NU): Market Capitalisation US$4.1b      
8. SES: Market Capitalistion $11.0b           
9. Severn Trent plc (SVT): Market Capitalisation GBP3.6b
10. PG&E Corp (PG&E): Market Capitalisation USD11369.01m

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The global equity market rally slowed down in March as Greece successfully restructured its debt but several global macroeconomic data points disappointed (BHP Billiton said Chinese demand for iron ore is flattening, US housing data was unexpectedly weak, Chinese and euro-zone PMI remained below 50).  For the month, the MSCI World index was up 1.76%, but MSCI EM was down 1.41% (in local currency with net dividends reinvested). 9 of 21 EM countries had positive returns in March.

The best performers were the Philippines (up 4.8%), Mexico (+4.6%) and Indonesia (+2.9%), while China (down 6.8%), Taiwan (-1.8%), and India (-1.6%) underperformed. China and Russia had the highest contributions to the overall index performance for the month. All returns are in local currency with net dividends reinvested.

Charles Hamieh spent two weeks visiting companies, regulators and government officials in South East Asia (ASEA) in March. The region is very well positioned. While China faces a labour crunch and regulatory concerns cloud India, SEA has experienced a rapid increase in Foreign Direct Investment. The region’s young population will allow the labour pool to grow from 388m to 444m over current decade (This contrasts with China where labour pool will soon decline and India which has huge pool of labour but heightened regulatory concerns). The middle class is expected to grow by over 50%, reaching 160m by 2015; with high-net-worth individuals to double in five years to 400k people. As a result, discretionary spending power is set to rise 80% in five years. Intra-Asean trade has enjoyed an 11% Cagr since 1992. The growth of Asean market is signified by the auto market where SEA just surpassed India as 3rd-largest market in Asia.

Infrastructure is the key benefactor of all these long term trends. Investment in infrastructure is the life blood of EMs. It provides a high return for governments and meaningful improvements for populations in terms of wealth and job creation

The strong government fiscal positions have lowered the cost of capital across the region. The implications for Infrastructure Investment are profound. After meetings with several key stakeholders (including high ranking government ministers), it is clear the focus is firmly on Infrastructure as the driver, and outcome, of economic growth. Governments are beginning to accelerate infrastructure spending. Most agree that a fair and transparent framework is in place with governments willing to offer provisions protecting against regulatory risk – this is important in ensuring project stability outlasts any administration. All these meetings reinforced our views and increased our conviction in the region.

We continue to maintain a very constructive view on emerging markets. For investors, investment in Emerging Market infrastructure has the potential to provide excellent growth, diversification and strategic benefits.

The US continued its strong start to the year in 2012, however the main focus during the month was on China & renewed ‘hard landing’ concerns. January Non farm payrolls in the US were above consensus again, at 243k vs 146k consensus. This follows the December report of 200k (vs 156k consensus). Whilst oil prices have retreated with simmering tensions

in the Middle East, Gasoline prices in the US remain elevated at $3.92 per gallon – and are viewed as a potential destabiliser to any rebound in US growth.

Infra Regulation:

*UK Airport operator BAA has mounted another legal challenge to try to avoid having to sell Stansted Airport. The Competition Commission (CC) ruled as far back as 2009 that BAA must sell Stansted in Essex and two of its other UK airports.

*Abertis (Spain, Toll Roads), also the operator of London Luton Airport, is seeking to fend off the local council’s threat to terminate the concession resulting from an argument of plans for expansion of the airport.

Infra M&A:

*CP2 sold 8% of its 12.5% Transurban (Australia, Toll Road) stake for AUD631m

*Goldman Sachs Infrastructure Fund, Borealis (Canada) and Marubeni (Japan) are rumoured to be bidding for Veolia’s UK water business

*The Hellenic Asset Development Fund has launched the tender process for the sale of Public Gas Corporation and its subsidiary, Hellenic Gas Transmission System Operator, with an invitation to submit EOIs for the assets.

*Aeroports de Paris (ADP) has reached an agreement with the owners of TAV Airports to acquire a stake in the Turkish airport operator. ADP will acquire a 38% stake in TAV Airports for EUR665m.

Infra Funding:

*Transurban raised CAD250m of maple bonds, Canadian dollar denominated bonds sold in Canada, the largest issue by an Australian non-financial issuer. The bonds paid a coupon of 3.368% to yield 170bps above 2018 Canadian govt bonds

*Veolia issued a EUR750mn bond with a 5-year maturity and a 4.62% coupon.

*RWE successfully USD500m hybrid bonds in Asia, offering a coupon of 7%. The bonds will mature in 2072 but RWE has a right to repayment after 5.5 years.

Other:

*Peru’s government said it plans to invest USD11.1b over the next five years in improving highway infrastructure, which would include 7,270km of road. USD3.7b will be invested in Public Private Partnerships (PPPs)

*Twenty pension funds, all from the UK, are in discussions with the Pension Protection Fund and the National Association of Pension Funds over forming a vehicle that would invest in projects highlighted in the UK’s National Infrastructure Plan II, published last autumn. According to the Plan, the government wants to invest GBP250bn into infrastructure over the next five years.

Pension funds worldwide are forecast to plough $3.5 trillion into new infrastructure projects over the next decade, raising their asset allocation from 2% to more than 15%. The investment would build 170,000 new hospitals or pay for 73,000 miles of three-lane motorway, enough to circle the globe three times.

Amarik Ubhi, lead infrastructure researcher at Mercer, the investment consultancy, said: “We could see pension fund allocations to infrastructure rise as high as 10% to 15%, and maybe even more.”

According to Towers Watson, global pension fund assets stood at around $27.5 trillion at the end of 2011. Investment consultants estimate that global pension funds currently have around 2% to 3% of their assets – amounting to around $500 billion, based on Towers Watson’s figures – allocated to infrastructure. A rise to 15% would be equal to $3.5 trillion of new money, at today’s prices,invested in infrastructure projects by 2022.

Luba Nikulina, senior consultant at Towers Watson, said: “There is increased appetite from pension funds across the globe in infrastructure as an instrument to get linkage to inflation and protect themselves against downturns.”

In her view, allocations of around 10% to infrastructure from global pension funds is possible over the medium term, with pension funds likely to transfer allocation from equities and fixed income to do so.

According to Joyce Shapiro, managing director of infrastructure and real resources at Franklin Templeton Real Assets Advisors, even US pension funds, which have lagged those of other big markets like Australia, Canada and Europe, are set to increase infrastructure investment dramatically.

Shapiro compared it with real estate, to which U.S. pension funds currently allocate around 9% of assets. She said: “Infrastructure will eventually equal, and even exceed, allocations to real estate over the next decade.”

Calpers, the $200 billion U.S. pension fund and the country’s largest, invested $155 million in Gatwick Airport in 2010.

www.efinancialnews.com

1. TransCanada (TRP): Market Capitalisation US$60.4b       
2. Transurban Group (TCL): Mkt Cap AU$7.5b 
3. National Grid PLC (NG/ LN): Market Capitalisation US$34.2b
4. American Water Works (AWK US): Market Capitalisation US$5.1m
5. Sydney Airports (SYD): Market Capitalisation A$5.0b
6. Southern Company (OS USA): Market Capitalisation US$33.6b
7. Northeast Utilities (NU): Market Capitalisation US$4.1b      
8. Spark Infrastructure (SKI AU): Market Capitalisation A$1.7b           
9. Severn Trent plc (SVT): Market Capitalisation GBP3.6b
10. SES: Market Capitalistion $11.0b

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The global equity rally continued in February as European leaders agreed on a second bailout for Greece and on strength in the US economy and despite climbing oil prices following tensions with Iran. The MSCI World index was up 4.73% and MSCI EM was up 4.5%. The US dollar weakened against most major currencies last month. In the emerging markets, EM Asia was the best performer up 5.25%, followed by EM EMEA up 4.00%, and Latina America up 3.19%. 18 of 21 countries had positive returns in February. The best performers were Egypt (up 14.93%), Thailand (9.83%), and Taiwan (6.74%), while Indonesia (down 1.01%), Peru (-0.88%), and Poland (-0.57%) underperformed. China and Taiwan had the highest contributions to the overall index outperformance for the month. All returns are in local currency with net dividends reinvested.

We noted last month that Indonesia’s parliament has finally approved the land acquisition bill. The government has now targeted toll road length to reach 1,666km by 2017. This implies an additional 906km (2012-14: 832km; and 2015-16: 74km) compared to 2011. Only 50% of land has been secured for the 10 prioritized Trans Java projects. There is another 349 ha of land to be acquired, a monthly acquisition of 35 ha in order to achieve government’s target of completing land acquisition process by the end of 2012. For JSMR, the law will play a critical role in the land clearing process for several roads which are located in densely populated areas.

We are getting increasing comfort on the medium and long term prospects for cross-border trade and the implications for the companies we invest in, particularly those with strong existing foundations in emerging markets. DPW and ICTS (the funds two largest port exposures) focus on regions (Middle East, Americas and Africa) that share common characteristics. Emerging Asia will likely overtake Western Europe to become the world’s largest trading region by 2015, with China the world’s largest trading nation by 2015. The potential of Africa is also strong, with expected healthy growth in the period 2010 to 2020. The appeal for investment in EM/ports goes beyond volume growth. Flexible labour markets, less intense local and international competition and a pipeline of brown-field projects with existing cash flow and quick pay-back are equally as important.  Economic and population growth will be supplemented by structural increases in the containerisation of trade as the nature of trade gradually shifts from basic commodities such as agricultural products and textiles to include consumer goods. Advanced economies currently generate more than 4x the container volume per capita than the BRIC economies. The facilitation of these trends is a key theme for the fund.

We continue to maintain a very constructive view on emerging markets. For investors, investment in Emerging Market infrastructure provides opportunities for excellent growth, diversification, and strategic benefits.

The global equity rally continued in February, buoyed by positive momentum on the US economy and EU leaders agreeing on a second bailout for Greece. However higher oil prices (crude ended the month at $107) and tension in Iran is a growing concern. Chinese & European manufacturing were a positive surprise, and US employment  and inventory numbers continue to strengthen. The tailrisk associated with the EU debt crisis continues to reduce as politicians agreed a second Greek bailout of EUR130b and the terms for private sector involvement were settled (74% write-off of current debt in NPV terms). There is still uncertainty as to the final participation of the private sector in the voluntary offer.

Infra M&A:

*South African, French, and Argentine companies clinched USD14.2b in concessions to expand and run three of Brazil’s busiest airports

*Enel (Italy, integrated electricity) placed a 5.1% stake in Terna (Italy, electric transmission), raising EUR281m

*The Portuguese Gov’t sold 40% of REN (electric transmission) for EUR592m (China’s State Grid acquiring 25%, with an additional commitment for EUR1.4b of investments and funding, and Oman Oil  acquiring 15%)

*Abertis (Spain, Tollroads/Comms) agreed to purchase Telefonica’s 13.23% stake in Hispasat (Spanish satellite operator) for EUR124m, implying a 2012E EV/EBITDA of 7.8x and an estimated equity IRR of 13%

*Cosan, a Brazilian ethanol, food, and agricultural company, and customer of ALL (Brazil, rail) agreed to buy 49% of ALL’s voting rights, equivalent to 5.67% of the company.  The deal was valued at R$896m (100% premium to the last closing price!) and raises a host of governance concerns

Infra Funding:

*Following the S&P downgrade of Spain & Portugal, Red Electrica (electric transmission) was downgraded from AA- to A+ and EDP (integrated electric) to BB+, and Enagas (gas transmission) from AA- to A+

*Enel issued EUR3b in 6yr retail bonds, at 310bps over swap, to yield 4.885%

*Terna issued EUR1.25b in 5yr bonds, at 257bps over midswap, to yield 4.125%

*Red Electrica issued EUR250m in 8yr bonds, at 4.55%. Further, the incoming chairman of the investment vehicle of the Spanish government (that holds a 20% stake in Red), declared the government has no intention to divest its position in the company. The sale of the stake was being planned by the previous Spanish government and created an overhang risk to the stock

*SSE (UK, integrated electric) said that it has completed a private placement of 5-12yr senior notes with US based investors for USD700m

Other:

*Japan’s government has threatened to withhold a Y1t (USD12.9b) financial rescue of Tokyo Electric Power, owner of Fukushima Daiichi nuclear power station, unless the struggling utility allows itself to be nationalised

When institutional asset managers want to smooth out volatility, one of the asset classes they turn to is global infrastructure.

But it’s important to understand the different classes of assets within infrastructure, and invest according to the growth prospects of the economy in which it operates, says Nick Langley, senior portfolio manager, RARE Infrastructure, and portfolio manager of the Renaissance Global Infrastructure Fund.

Langley says the sector can be broken down into two main categories: regulated assets and unregulated assets.

Regulated assets include power, gas and water delivery infrastructure, and are subject to periodic pricing resets as dictated by the regulator.

“The regulators tell those companies how much they can earn, and if they earn too much money, they have to give some back to their customers,” he explains. “If they are under-earning, and are a good company, they can increase their prices to bring their income up to the right level.”

These companies are less exposed to market cycles and are generally seen as defensive investments, due to the long-term exposure they provide to the underlying asset.

Examples of unregulated infrastructure include ports, toll roads and airports.  Because these are concerned with moving goods about within the economy, they are far more exposed the market and economic cycles.

“Those are the sorts of companies you want to own coming out of a recession or economic downturn,” he says. “As you’re going into a downturn, you’re going to want to hold more of the utilities, the regulated infrastructure.”

Due to the presently uncertain nature of the global economy, he is tilting his portfolio toward utilities, and is steering clear of Eurozone as the fount of uncertainty.

“If you look at the UK and the U.S.—yes we’ve had some strengthening growth in the U.S., but we aren’t sure where it will head from here—we have a lot of utility exposure,” he explains. “In Latin America and across Asia, where we have a lot more growth coming through, we have a higher exposure to infrastructure assets.”

He expects the U.S. will finally regain its status as the global economic growth driver in 2014 or 2015, providing China with a breather from that role.

Originally published on Advisor.ca

The UK Government published its Water White Paper in December 2011, setting out proposals for reform.  This included: the start of a process to reform the water abstraction regime, so that the value of water and its relative scarcity is better reflected to customers; ideas of how interconnection could be encouraged; a simplified licence system to facilitate greater upstream competition in the supply of water; and a progressive increase in those customers able to choose their water supplier.

Consultation on this will proceed during 2012. In addition, The Water Industry Financial Assistance Bill is currently passing through the legislative process, and is expected to have a second reading in the House of Commons in early March 2012. This Bill will allow the UK Government to provide financial support for major pieces of infrastructure, and is intended to allow for the financing of the Thames Tunnel.  The Bill also provides for subsidies to lower customer bills, intended to allow for a subsidy of customers in the South West of England. Separately, the UK water regulator is consulting on changes to the method for reviewing price controls a the next five yearly review, which will take place in 2015.  

In our view, the current regulatory framework is relatively transparent, and gives well-managed companies incentives to control capital and operating costs.  However, we also recognise that the UK water and sewerage industry faces a number of long-term challenges, with a need for continued high levels of investment in part associated with adapting to climate change, population growth, and increasing environmental standards.  We believe that it is possible to reform the incentives placed on companies using market mechanisms, in a way that maintains the attractiveness of water and sewerage companies to equity investors.  One way to do this has been set out in Stern & Mirrlees-Black (2011).

RARE Infrastructure has exposure to the UK water sector.  We welcome the statements made by the regulator and government about the need to maintain investor confidence during this reform process, and will continue to monitor developments for threats and opportunities it places on the listed water and sewerage companies. 

Financial Times, 19 February 2012, Call for Fresh Push to Trade Water. Available at http://www.ft.com/intl/cms/s/0/bfeb388c-5b10-11e1-ab75-00144feabdc0.html#axzz1ntWioKGF

HM Government (2011).  Water for life. Available at  http—www.official-documents.gov.uk-document-cm82-8230-8230.pdf.  

Stern & Mirrlees-Black (2011).  A framework for valuing water in England & Wales from 2015 onwards.  Working paper 19, Centre for Competition & Regulatory Policy, City University, London.  http://www.city.ac.uk/social-sciences/economics/research/centre-for-competition-and-regulatory-policy/papers.  A summary is available at http://www.oxera.com/main.aspx?id=10065.