Foreign investors are likely to provide the bulk of funding for Australia’s huge infrastructure projects, with domestic players unwilling to venture into the sector.
Superannuation changes have meant that long-term Australian investors are no longer keen to commit to the ambitious projects.
And the lack of domestic demand for the funding of such projects has meant that authorities are increasingly tapping Chinese investors.
Despite having the world’s fourth-largest pool of pension assets, with its superannuation industry managing A$2 trillion ($1.4 trillion), Australia’s state governments are rolling out the red carpet to Asian and other foreign investors as they embark on massive domestic projects.
New South Wales has allocated A$68.6 billion to infrastructure over the next four years, including A$38 billion for road and transport projects; it will lease the state’s electricity assets to free up a further A$20 billion to plough into infrastructure.
Its government co-hosted a conference in Sydney in July in conjunction with China’s Boao Forum for Asia to advertise its investment needs.
Mike Baird, premier of New South Wales, called the NSW infrastructure agenda its biggest in a generation. It will require partnerships in finance, engineering and construction. His government is pitching investors from China and elsewhere.
Chinese interest is real. Ma Zehua, chairman of China’s shipping giant Cosco, was at the Boao event in Sydney to talk about the benefits of interconnectivity and Beijing’s ‘one belt, one road’ plan to finance infrastructure.
With a China-Australia free-trade agreement inked this year, groups such as Cosco will be keen to provide construction and engineering expertise to enhance Australian ports and their affiliated roads and railways.
The free-trade deal will mean that plenty more Australian agriculture and resources will head to China, while state governments such as NSW must also build the infrastructure to accommodate a rising number of Asian students and tourists.
But why does Australia need foreign investors to support its infrastructure needs, when it has a massive pool of domestic capital, whose managers are experienced with the asset class and would like to put large chunks of cash to work?
“It’s a puzzle,” Baird told AsianInvestor. He said the government had tried to finance projects by issuing long-term municipal bonds, but there was little demand beyond 10 years. “There’s no appetite,” he said.
Australia’s bond market remains small relative to its GDP, with government issuance about 45% of GDP (compared to over 100% for the US). The majority of bondholders are non-residents, attracted by Australia’s triple-A rating (which extends to the NSW government).
According to the Reserve Bank of Australia, the average tenor for state bonds is about 5.4 years, and 6.5 years for federal (Commonwealth) government bonds. The local bond market cannot finance long-term projects.
But why is there no demand from domestic institutions with long-term liabilities? The answer is simple: superannuation is no longer a long-term game.
The rise of self-managed superannuation has transformed the industry, morphing it into a defined-contribution environment. Self-managed supers, in which one to four individuals act as both manager and trustee, account for a third of industry assets.
Even within industry schemes, the introduction of member choice in 2005 allowed employees to switch their assets among a variety of scheme portfolios.
This retail-isation of the industry means even big, established funds must maintain high cash levels to meet redemption or switching requests.
Richard Brandweiner, CIO at First State Super, explained that his fund – which is large but otherwise typical – has an investment target of 4.0% to 4.5% over inflation.
Although funds are attracted to the long-term nature of infrastructure assets, they also need to remain liquid. At First State Super, only 20%-25% of assets can go into illiquid exposures.
Moreover, illiquid assets now must pay a high premium. Because pension funds have become short-term in nature, they are keeping up to 30% of assets in cash and bonds.
Interest rates are low, so these investments don’t beat inflation. That means illiquid assets – including hedge funds, private equity and real assets – must really deliver high returns to compensate.
For the full feature on Australian infrastructure, read AsianInvestor magazine's forthcoming September issue.