City of Baltimore Fire & Police Employees' Retirement System
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DIVERSIFIED REAL ASSETS MANAGER SEARCH CITY OF BALTIMORE FIRE & POLICE EMPLOYEES’ RETIREMENT SYSTEM September 2019 Kristin Finney-Cooke, CAIA, Senior Consultant Kevin Leonard, Partner Andrew Brett, Director of Real Asset Research BOSTON | ATLANTA | CHARLOTTE | CHICAGO | DETROIT | LAS VEGAS | PORTLAND | SAN FRANCISCO REAL ASSETS PLAN RECOMMENDATION • NEPC recommends the following investment pacing model to achieve the target allocations: – 2019: Committed $30 million to a LaSalle Income & Growth Fund VIII; commit $40 million to a diversified real assets fund(s) and redeem $20 million from core real estate • NEPC has provided four managers that have been profiled in the book to be interviewed as finalists – Landmark, Private Advisors, Brookfield and JLC • NEPC recommends two managers be selected for the 2019 diversified real asset fund mandate, each receiving ~$20M – Landmark or Private Advisors – Brookfield or JLC • Landmark and Private Advisors are both multimanager real asset strategies focused primarily on investing through secondaries and co- investments – Landmark will have a infrastructure focus – Private Advisors will focus across the real assets spectrum (e.g. energy, infrastructure, metals and agriculture) • Brookfield and JLC are both high quality infrastructure funds 2 REAL ASSETS • “Real assets” refers to the ownership of a hard asset and/or access to a natural resource – There are many sub-strategies within real assets, and most can be accessed through public or private markets • Hard asset sub-strategies can include: – Real Estate – Infrastructure – Timber – Agriculture • Natural resource sub-strategies can include: – Energy (extraction and/or transportation) – Metals (extraction and/or transportation) – Commodities • Real assets are typically included in a portfolio for diversification benefits, to offer a partial hedge against inflation, and/or to maximize total return – Investor objectives (which vary) can inform sub-strategy allocation targets – Some investors include inflation-linked securities (such as TIPS) in a real assets portfolio due to the inflation sensitivity 3 REAL ASSET MARKET AND 2019 VIEWS General Market Thoughts • Select opportunities remain for Energy private equity • Attractive opportunities in Infrastructure and related operating businesses – Focus on “buy-fix-sell” strategies and managers with operating expertise – High valuations for large transactions create poor entry points for core exposure – Higher yielding opportunities may exist in niche sectors (e.g., aviation leasing) • Improving Metals & Mining fundamentals but implementation is challenged • Agriculture fundamentals interesting but limited manager universe • Limited opportunities in Timber given low yields and liquidity Implementation Views Strategy Outlook Commentary Continue to see select attractive private equity opportunities; small Energy Positive players can be more nimble; large allocators can be strategic with acquisitions Continue to find attractive opportunities and a need for capital outside of Infrastructure Neutral/ core assets; favor managers with operating expertise who can drive asset (core/non-core) Positive cash flow growth and/or managers targeting yield-oriented niche assets Renewables Neutral Favorable macro tailwinds supportive, but regulatory risks remain Focus on managers with geological and technical expertise; limited Metals & Mining Positive implementation options Agriculture Positive Slowing appreciation creates attractive entry point; difficult to implement Timber Negative Less attractive due to low yields and illiquidity 4 INFRASTRUCTURE OVERVIEW NEPC, LLC INFRASTRUCTURE OVERVIEW Infrastructure assets are generally defined as physical facilities or networks that provide essential goods or services to a broad range of users ➢ Infrastructure assets may be owned privately or through publicly traded securities • Infrastructure assets may generate a return through a combination of current income and/or capital appreciation • Characteristics of Infrastructure Assets – Long duration assets with stable cash flows typically tied to inflation – Monopolistic or quasi-monopolistic assets with significant barriers to entry – Operate in regulated environments – Capital intensive assets with high replacement costs • Large infrastructure investable universe – Over $69 trillion of global infrastructure investment required by 2035 – Over $580 billion of total capital raised by closed-end fund managers since 2005 – Publicly traded infrastructure equities account for over 350 companies globally, with a combined market cap in excess of $3 trillion • Investments can be made across the asset lifecycle – Greenfield, brownfield, and operating assets 6 INFRASTRUCTURE SUB-SECTORS Energy & Transportation Communication Social Utilities Renewable Wireless Education Toll Roads Power Towers Facilities Electricity Broadcast Healthcare Bridges Generation Satellites Facilities Electricity Cable Tunnels Courthouses Transmission Networks Water & Fiberoptic Airports Waste Lines Oil & Gas Seaports Pipelines Rail 7 INFRASTRUCTURE SECTORS Holding Typical Primary Return Sector Asset Focus Period Returns Drivers • Toll Roads • Bridges 10-15 years 5-7% Current Income • Tunnels Transportation • Airports Current Income & • Seaports 10-15 years 8-10% Capital Appreciation • Rail & Transport Current Income & • Electric Generation 8-12 years 15-25% Capital Gains • Electricity transmission and Energy & Utilities distribution networks Current Income & • Water and waste 10-15 years 8-15% Limited Capital • Oil & Gas pipelines Appreciation • District energy • Renewable power • Wireless communication towers Current Income & Communication • Broadcast satellites 8-12 years 10-15% Capital Gains • Cable networks • Communication towers • Education facilities Current Income & Social • Healthcare facilities 10-15 years 5-7% Limited Capital • Courthouses Appreciation Note: “Typical returns” are illustrative examples only, actual target or realized returns may vary for all sectors. 8 INFRASTRUCTURE LIFECYCLE Prolonged Period Prior to Cash Flow Growing Income Stable Income Greenfield Brownfield Operating • Assets requiring • Assets that are operating • Assets that are operating development and and generating cash flow and generating cash flow construction which may • Distributions will increase • Steady distributions from introduce operational during growth/ramp up revenue generation complexity periods and level off as an • Usage typically grows at • In certain cases asset matures approximately the rate of development/construction • Longer operating histories GDP Growth risks can be outsourced to support more predictable third parties and various cash flows structural elements can be introduced to provide a greater degree of revenue certainty 9 ROLE OF INFRASTRUCTURE IN A PORTFOLIO NEPC, LLC GOALS OF INFRASTRUCTURE ALLOCATION Income • Stabilized assets generate predicable cash flows meaning a significant percentage of returns can be generated from cash distributions Inflation Protection • Inflation-linked cash flows provide natural hedge to rising liabilities Diversification • Low correlation to other asset classes Downside Protection • Attractive total return potential with lower volatility generates attractive risk-adjusted returns and serves as downside protection 11 PORTFOLIO FIT • Infrastructure investments fit into an overall portfolio as a standalone allocation or as part of a broader allocation – Infrastructure – Real Assets – Alternatives – Inflation-Hedging • Depending on the sub-strategy, some infrastructure strategies share characteristics with real estate and/or private equity – Similarities to private equity: • Operationally-intensive • Portfolio company management team in charge of day-to-day operations – Similarities to real estate: • Fees for service are predictable and stable • Inflation-adjusted revenue streams • Asset location as a key consideration or advantage • Some infrastructure investments may also be considered as part of a real estate allocation – Some infrastructure asset classes are more real estate-like than others; for example: • Senior Housing (real estate or social infrastructure) • Data centers (real estate or communications infrastructure) 12 CONSIDERATIONS • Infrastructure is not a “one size fits all” asset class; the mix of various risk/return strategies should be customized based on client objectives • In constructing an infrastructure portfolio there are several key considerations that impact the allocation, including: – Plan investment policy – Plan inflation sensitivity – Allocation to illiquid alternatives – Liquidity requirements of plan – Existing infrastructure investments • A global infrastructure investment strategy may benefit from diversification as various regions are at different points in an economic cycle – Global managers tend to be large platforms with investment professionals around the world while non-US managers may be more localized in a particular region or country • However, there are some considerations of investing in infrastructure outside of the US: – Currency risk – Geopolitical risk – Market liquidity risk – Limited inflation hedge 13 RISK & RETURN FACTORS • There are several factors to consider when assessing the overall risk and return of an infrastructure investment Canada, U.S. Other OECD Western Europe, Emerging Markets Geography Countries Australia Operational Maturity Operating Brownfield Greenfield Prolonged period Operating Income Stable Income Growing Income prior to cash generation