alternative asset classes for pension funds
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Alternative Asset Classes for Pension Funds Transforming Need into Opportunities: Financing Infrastructure Trough Capital Markets –The Inca Model
National Pension Commission of Nigeria and The IFC Abuja March 2008
Johan Kruger
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Topics The Democratisation of South Africa The Rationale for an Intermediary The INCA Model Prerequisites for Pension Fund
Investments In Infrastructure The Advantages of Infrastructure
Investments Possible Intermediaries Conclusion
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The Democratisation of South Africa
Pre Democratisation Local Authorities White, Black, Indian,
Coloured White -economic base –strong cash flow-
institutional capacity-good infrastructure-Government support – no problem accessing capital markets
Black etc - no economic base-grant dependant=weak institutional structure-inadequate infrastructure-no private funding
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The Democratisation of South Africa
Post Democratisation Priority amalgamation of local authorities Investor withdrawal
Service Boycotts Tremendous Backlogs Lack of policy framework
Fruits of the new South Africa has to be delivered
Market gap in private sector infrastructure funding
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Rationale For Inca Local authority portion minute in
comparison with total contractual savings institution’s portfolio (0.2%)
Lack of understanding of local government
Uncertain policy environment But
Private sector know they must invest or jeopardise stability of Country
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Inca Started in 1996 with $10 m Peaked in 2004 at of $1000 m Portfolio Started in response to government appeal
to private sector Structured as intermediary between
infrastructure providers and capital markets
Listed and rated bonds on market Created two subsidiaries:non profit
capacity building fund and distressed bond company
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Basic Business case
Classic aggregation/disaggregation intermediary
Issue bonds in domestic market and conclude international loans to raise money
Pre approved credit limits Provide funds to borrowers
Amortizing or bullet/coupon Bulk is on balance sheet lending
Provide assistance trough an non profit company
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The Inca Model Offers investors
Understandable financials of single entity Opportunity for social investment Market related return - listed and AA-
rated bond Liquidity by market makers Diversified risk and equity/reserve buffer Dedicated expertise & risk assessment Second corporate bond in South Africa
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The INCA Model (2) Offers Local Authorities
Access to private sector finance Reasonable rates given risk profiles Transparency Assistance
Offers Shareholders Opportunity to invest at market related rates Benefit of participation
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Structure of Inca Choice of shareholders
Financial institutions Empowerment and gender partners DFI’s ( political insurance and credibility)
Rated (AA-) Back to back bonds in inception phase
no interest rate risk No expensive treasury Government stock hedging
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Structure of Inca (2) General obligations Computerised credit model
Pre assessment Shadow rating Turn around time 3 weeks Determines capital requirements Determines pricing Caveats
Limited but incentivised staff Non banking entity International Funding
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Capital Structure Of Inca Equity
Mezzanine debt
6%• Return
Govt plus 12-14%
23.5%• Return
Govt plus 2- 3.5%
70.5% • Return Govt plus 0.8-2.0%
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Credit ModelSolvencyLiquidityTurnover
StandardizationIncome
Cash flow
Diversity of taxGrowth indicatorsPhysical factors
ManagementCompetence
Dispute resolutionsBacklogs
Payment levels
Financial position
Economic environment
Institutional capacity
Socio-economic analysis
Environmental PoliciesPractices
Score
Peer Deviation
Potential problem areas
Shadow rating
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Capital,pricing,caveats
Typical Projects
Funding of: Municipal and regional
infrastructure Roads Sewerage Water Electricity other
Parastatal infrastructure14
Performance Portfolio peaked in 2004 at more
than $ 1 Billion Defaults never exceeded 0.2% Return to shareholders always in
excess of 20% Capacity building fund had a major
Impact
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Prerequisites for Successful Intermediaries
Rule of law –fair and timely Decentralised authority and autonomy Creditworthy or credit enhanced borrowers Acceptance of cost recovery principles and/or
appropriate subsidy where required Developed capital market – access - yield curves to
price risk- tradability Risk/reward in balance Clear policy framework Capacity to deal with defaults Trust from investment sector in management Credible shareholders
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Prerequisites for Pension fund Investment in
Infrastructure Pension fund’s first responsibility is to
their members Risk must be acceptable Reward must be market related and
competitive Appropriate listed and rated tradable
instruments must be available Long term yield curves Must be socially acceptable projects
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The Advantages of Investment in Infrastructure
Natural match between long term fixed rate requirement of infrastructure funding and the long term needs of the contractual savings sector
Diversification opportunity Higher yields possible Stimulates economic growth Benefits members
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Risks for Pension Funds
Failure of infrastructure providers Failure of intermediary Market risks Reputational risks In Nigeria administration problems
with intercepts
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Possible Borrowers and Intermediaries
State governments Local authorities Utility Companies Private sector intermediaries
UDBN Banks Spv’s
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Conclusion
Infrastructure is a natural area for the pension fund industry and Inca
in South Africa has proved the viability of investment in
development
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