When it comes to investing in telecommunications exchanges, most asset owners grapple with a tough question: ‘Does the asset classify as real estate or is it infrastructure?’.
The reality is that, similarly to data centres, telecommunication exchanges straddle the two asset classes, and can easily fall between the cracks.
The decision to acquire a share in a portfolio of telecommunication exchanges was pretty clear-cut for Miriam Patterson, Head of Real Assets with TelstraSuper, which, despite its relatively modest size, is a large institutional investor in real assets in Australia.
“At TelstraSuper, we decide whether we like an investment and then we find a home for it,” she says. “That is one of our strong guiding principles.
“If I look at an investment and it doesn’t fit into a box perfectly – like retail, industrial or office – it doesn’t mean it is not a good investment. You need to look at the cash flow, and the risk surrounding that cash flow.”
At TelstraSuper, we decide whether we like an investment and then we find a home for it
So it was that, in August, Australia’s largest corporate super fund, with some $22 billion under management, made one of its biggest commitments to an investment that does not necessarily fit neatly into real estate, infrastructure or even social infrastructure.
TelstraSuper went into partnership with Charter Hall Group and one of the group’s listed vehicles, Charter Hall Long WALE REIT (CLW), in a successful $700 million bid for 49 per cent of a portfolio of telecommunications exchanges.
The partners are co-investors with Telstra, which had earlier created a dedicated single purpose property trust to hold the assets as part of a strategy to recycle capital. Telstra retains a 51 per cent interest in the trust.
Charter Hall said at the time that it would manage the partnership, owned 50 per cent by CLW, 28.2 per cent by a wholesale capital partner (TelstraSuper) and 21.8 per cent by Charter Hall (on its balance sheet).
Charter Hall acquired the portfolio through an arms-length international sales process conducted by UBS.
The merits of such an investment, where TelstraSuper can exploit the adjacency between infrastructure and real estate, were obvious to Patterson because she was not ‘brought up’ in real estate and, therefore, was not locked into a certain mindset.
When the opportunity to partner with Charter Hall came up, she could see immediately a portfolio that generated stable, inflation-indexed rental income, underpinned by scarce land in high-quality locations.
The 37 telecommunications exchanges are leased back to Telstra for an average term of 21 years, some with the option of further extension on staggered expiry dates.
It is quality of income that is the key for Patterson, who says she is ‘sector agnostic’ and her investment choices are ultimately guided by the durability of income streams.
I have to sell something to buy something, so I need to be very disciplined
TelstraSuper has a culture of seeking out opportunities that defy conventional description. Its long-held Sherwood Bus Terminal, in central Brisbane, is another case in point. Brisbane City Council is the tenant.
“These assets have the right income profile and risk-return characteristics,” she says. “The income has to be durable over the long term, typically with either fixed rental escalation or linkages to CPI.
“Obviously, you still have regard for the outlook for the sector, and you tilt accordingly. In infrastructure, you are really laser-focused on the quality of the cash flows, as well as the creditworthiness of the counter party, which, in real estate, is the tenant.”
To understand why durability of income is a central consideration, one has only to look at TelstraSuper’s membership profile.
The average balance of its 95,000 plus accounts is around $230,000 – one of the highest of any fund in the country.
TelstraSuper members are older, and have therefore built up higher balances compared to a ‘young’ fund such as Hostplus, where the average member is under 35.
With longer investment horizons, many industry super funds have targeted growth assets. But not TelstraSuper.
It has placed a greater emphasis on strong and sustainable cash flows. With a membership base closer to retirement comes the need to lock in income security.
As a corporate fund, TelstraSuper does not have the rivers of contributions enjoyed by industry funds. Rather, it has modest inflows.
“I have to sell something to buy something, so I need to be very disciplined,” says Patterson. “I have to think very hard to sell an asset from our very high-quality portfolio to buy something else.
“My comparison is not just cash. The new acquisition has to be measured against a much higher benchmark.”
Incomes are one part of the equation when Patterson makes an investment decision. The other part is future potential of the assets.
She told [i3] Insights: “The questions I have to ask are: Is there an alternate use of the land? Where is the location? Can I re-lease or can a new operator step in, and does the investment make sense for the fund?”
These basic premises underline all of TelstraSuper’s real asset investments, whether in property or infrastructure, or whether an investment borders on the two asset classes.
In terms of pure infrastructure, and because of their ticket-size, TelstraSuper leaves the choice to its selected half-dozen managers, including Global Infrastructure Partners, based in New York, and Morrison and Co, based in Sydney. Over half of TelstraSuper’s infrastructure investment is offshore.
Its allocation to pure infrastructure stands at 6 per cent of funds under management, or around $1.1 billion. Returns from infrastructure have been in the strong double-digit column over a seven-year period.
Patterson, who became Head of Real Assets at TelstraSuper in 2015, started her career with the international accounting house, EY. During her time with EY she worked in valuations, in part valuing infrastructure assets for clients.
“In this age of populism, when the issue of inequality dominates politics and leads to social unrest, instability and uncertainty, returns from infrastructure could come under pressure, particularly essential services such as utilities
She moved on from EY to Hastings Funds Management, an infrastructure manager. Hastings was broken up last year, with its domestic business taken over by Morrison & Co, and the international business going to Northill Capital in the UK.
It was during her time at Hastings that Patterson developed an appetite for the infrastructure asset class.
Asked how her perspective has changed when looking at an asset from the lens of an owner as opposed to that of a fund manager she says: “Your mission is very clear.”
The fundamental value of an asset permeates every single deal, she says, whether investing as an owner or buying for an investor.
“The difference is: you are closer to the line of money. It makes your purpose clearer and very simple. There is no conflict between profit-making, returns or funds under management.
“We are here to do the right thing for members, and that means getting the best risk-adjusted returns we can find.”
Patterson was just 33 when she left Hastings to join TelstraSuper in 2011. She chose it in preference to other job opportunities because superannuation is a growth industry.
While she can future-proof her investment with commercial agreements like long-term leases, Patterson is, nevertheless, not without worries of the future. Regulatory risks loom large in infrastructure.
“In this age of populism, when the issue of inequality dominates politics and leads to social unrest, instability and uncertainty, returns from infrastructure could come under pressure, particularly essential services such as utilities,” she says.
British Labor leader Jeremy Corbyn is openly talking about nationalising water companies and other now privatised infrastructure assets in the UK, if he wins government in December.
There are other issues, too, she says, including climate change, rising sea levels and disruption, particularly in infrastructure.
“The concern is that you could be left with a stranded asset. These are the kinds of things that can keep you awake at night.”
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.