Infrastructure equity's resilience in disrupted markets

Stewart: My name's Stewart Foley, I'll be your host. Today's topic is infrastructure equity and we're joined by John Anderson, Global Head of Corporate Finance and Infrastructure at Manulife Investment Management, and at John Hancock Life Insurance. John, thanks for taking the time. Thanks for being on.

John: Hey, great to be here, Stewart. Thanks for having me on.

Stewart: We're thrilled to have you. You are unique in that you have one foot in the asset management side and the other foot on the operating side and the GA, and I want to talk about that and I want to go there. But before we get going too far, where did you grow up? What was your first job? Not the fancy one. And what makes insurance asset management so cool?

John: Well, thanks, Stewart. So I grew up in Wilmington, Delaware, and my first job out of university, I served as an intelligence officer with the Central Intelligence Agency for three years during the Cold War under President Reagan and enjoyed that tremendously. And then the Cold War wrapped up and it was time to move into the private sector. So I've been doing that for about 30 years in the infrastructure space, a little bit more banking, and then moving to Manulife in 2001.

And I would say on that, what makes insurance asset management fun, I've really enjoyed that we can't get redeemed out. As we're building portfolios to pay policy holder benefits, we know that we have a long time horizon to build our portfolio so we can get involved in a lot of really interesting stuff that maybe is more analytic, but it's also has higher impact and it has better returns. And we don't have to restrict ourselves to something that we can sell on public markets that's got a dig deep liquid pool of investors. We can focus on specialty sectors that offer great value, resilient returns, and are just fun to be involved with and have a lot of innovation associated with them.

Stewart: That's really cool. I think that the time horizon for life insurance companies is definitely a competitive advantage over a long period of time. And I get a chance to talk to a lot of people quite frequently on the show. And I hear a lot about infrastructure and I don't hear a lot about infrastructure equity. I hear more about infrastructure debt, but I want to know what you think about infrastructure equity and if you can give us some high points of examples of what kinds of assets that we're talking about and a little bit of background on, I mean, you've been at this for a minute. I think that it always is helpful to cover that ground whenever we're talking to an investor as well.

John: Yeah, that's great Stewart. And it's not surprising that we'd spend a lot of time in the insurance world on infrastructure debt because a lot of insurance companies have large allocations to infrastructure debt, as do we, because long duration, well protected assets, great space to invest, and that's what got our firm interested in infrastructure equity. So that contracted power plant against which you can do 20 year bonds for your debt book, well, you can also hold the common equity of that asset and you've got a low volatility equity position that's giving you attractive equity returns, but that doesn't move up and down with economic cycles. And so that's really what drives, at Manulife, our big overweight infrastructure equity is that same stability of the underlying, whether that's a wind farm or a solar park or a data center or a toll road.

Stewart: And in your mind, where does infrastructure equity sit in an insurance company portfolio? And in your world, you're dealing with life companies and we have life and P&C in our audience, but for the most part we're focused on the life sector right now. So from your perspective, how does infrastructure equity fit when you've got your GA hat on?

John: Yeah, so the way we build our general account portfolio, if you look at the global life insurance portfolio on average, we're about 85% investment grade debt and about 15% alternative assets, very simplistically. And then within alternative assets, we've got about a 25% allocation to infrastructure equity. And the reason we have that overweight is that we're looking for something with attractive equity returns that are resilient during down cycles. And so what that means is we're still getting our target returns during the global financial crisis, during the Covid shock of 2020, during the inflation rate shocks of 2023. And that's just helpful to the overall book to have at least part of your alternatives still generating nice cashflow and holding up well during times of stress that allows you, as an investor, to be on your front foot into a disrupted market, actively investing, not having to pull back because your portfolio is under pressure.

Stewart: So whenever I talk to somebody in your seat, I try to put on my CIO hat for a minute. So what are the different ways that I can buy infrastructure? And can you talk about the risk return associated with each one of those strategies?

John: Yeah, absolutely, Stewart. So the way that you can play infrastructure equity, I think there are a couple of different directions that investors go. So one is a decision whether you want to participate in a global program or whether you want to be more regional. And for example, at Manulife, we invest very heavily in focused US market strategies because we believe that the United States is the largest opportunity set and it's the one we're most comfortable with. But then we also have part of our program invested in global managers to give us some diversification. So that's one crossroad is do you want to focus on your home market or North America or do you want to go global and maybe some of both is good.

And then you'll get different levels of risk return. And we've borrowed terms from the real estate industry and we'll talk about core plus value add as levels of risk return. They don't fit perfectly in infrastructure because they really were adopted from equity real estate, but it gives us a framework that maybe allows people to get started on what are we talking with. And so if core in real estate would be fully leased office buildings Class A office in a gateway city, in infrastructure we would talk about core infrastructure being something like a fully-contracted solar park or maybe a regulated utility with fully-regulated rates, cost pass-through of operating costs, and with a similar return for that low-risk profile that you have in that case. Although I think today, we're feeling better about poor infrastructure than we feel about Class A office, for example.

I think then you can go to core plus, which in our program would be maybe a company that has some existing assets, so you get potential downside protection, but maybe they're going to add some more data centers or some more solar parks to the portfolio to give us some growth upside. Or maybe it's a bridge repair program where we're going to take some construction risk and we're going to get paid a premium to track construction and come in before the project has been built. And then the higher risk return would be more value added. And maybe that's going to be taking an infrastructure division that wasn't really so much loved in its previous owner and maybe under independent management can do more. Maybe there's an opportunity where they don't really so much own the assets, but they're developing the assets and selling them to other people. Those can be more value added opportunities.

Stewart: And can we talk a little bit about the last couple of years has seen a real pronounced increase in interest rates, although we've seen a little bit of a pullback of late, how do we contend with the relatively high capital charges associated with this asset class? And I'm referencing regulatory capital charges here.

John: For that one, Stewart, we've developed our overweight in that high capital charge environment where it bears the same capital charges as private equity. And for us, it still makes sense because it's got much less volatility than private equity. So our program can show one quarter of the volatility of public equity and one half the volatility of the infrastructure equity index. So for us, with that low vol, even with the capital charges, it's a good fit. It is carrying the same capital charge as private equity and it has lower volatility, so we do think the charge is higher than it should be. And depending on the jurisdiction, regulators are sympathetic to that. And now and again, we can get some capital charge discounts, but we don't rely on that. That hasn't driven our program growth.

Stewart: And you actually, based on my notes, you have developed the Manulife Infrastructure Investment program. Can you tell me a little bit about how that started and what was your vision when you first started it and how has it changed and evolved over time, as I'm sure that your team has gotten bigger and your invested asset base has gotten bigger too?

John: You're right on, Stewart, and it's been a really great journey. So I joined the firm in 2001 and we have grown infrastructure dramatically since then. And we ran the US infrastructure team. The way I led the team was investing in public debt markets. That could be utility lending in the public bond market, private debt markets, that could be project finance lending in the private placement market, that could be also direct infrastructure equity, which we've been doing for 23 years, and then it also could be investing in infrastructure funds, which we grew after the direct program to give us diversification. And a couple of things are going on there. So one is if you're making 50 year promises selling life insurance, infrastructure's got a lot of good stuff you can buy. So it's a good place to build an infrastructure program because you've got an investor who likes utility bonds, those private placement financings for wind farms and solar parks, but also, the common equity positions that go alongside that, and then the fund offerings.

And what I also drove was coming out of a banking background where I'd been in infrastructure banking teams. There's a concept there called multi-product cross sell. Let's understand the target industry super, super well, and then we can figure out how is that investible and where can we add the most value to our customers? So we had our debt and our equity teams, our public teams and our private teams always talking to each other so that if a new opportunity came up, we could be first to it in whichever asset class was the right investment at that time. And also, everything we're learning from each program helps us be smarter in the other programs. And that was a lot smaller in those days when I started, but today at Manulife, that's more than $40 billion of infrastructure debt, a $10 billion direct investing program in the US, and then a $5 billion global fund of funds program.¹ And we still try to keep that market intel and bringing everything we know to everything we do as part of the program.

I will say when we were smaller, it was easier to have a dedicated US team with the same officers doing public debt, private debt, direct equity fund investments, and sit on fund ELPACs and underwrite all of these and be talking to the same customer. That ended up being hard to scale. And so as we've grown, we have needed to move more into specialization. So today we have a direct equity team focusing on the US, that's what they do. We have a global fund to funds team, that's what they do. We have an infrastructure debt team, that's what they do globally. But we still try to keep the information linkages and the conversations going between the teams, sharing market intelligence, sharing views on new developments in the industry to try to get the best of both.

Stewart: When you talked about going between having a domestic or US only program versus a global program, to what extent does the nature of your liabilities come into play there? I mean, is that a consideration or are you trying to fund specific liabilities with your global program or are those independent decisions?

John: We can take advantage of the global demand. So Manulife as a life insurance group, our core earnings are one third US, our largest market, one third Canada, the home market and one third East Asia, our fastest growing market. So all three of those programs participate in our infrastructure equity program. And all three of those investors participate in our infrastructure debt program. So at the group level, we are looking for, whether it's Canada, Asia or US, we want them to take advantage of Manulife's global investment management capabilities. It also then, for example, I'll go to infrastructure debt where we do the most multicurrency work. In equity, we usually come back to, it's usually either dollar or euro or sterling overwhelmingly, but in the debt program, you can go multicurrency and then swap back to the book of the client that needs it.

And so in US dollar for John Hancock, there's a lot of opportunities around the world for Manulife Canada. We're already a huge lender to so many of the good infrastructure companies in Canada, and then we end up getting concentrated. So for them, we're looking hard to find new opportunities to land in Europe. And the swap across sterling or euro makes a lot of sense. And then for our customers in Asia, Manulife Singapore, Manulife Hong Kong, we can show them so many more opportunities than if they just stayed in Singapore dollars or Hong Kong dollars. We can give them a really nice globally diversified portfolio and program. So having the global bid and then the global insight into different markets, there's a real synergy there that we spend a lot of time taking advantage of for our customers.

Stewart: And so when you built this, and I guess there's some discussion that happens around how a team is actually structured, right?

John: Yeah.

Stewart: And there's a lot to it. I mean, it depends on the insurance company, it depends on, you've got third party assets. So can you talk a little bit about how the Manulife team is positioned to invest in the infrastructure space?

John: I'll go in the direction of how we serve our customers, if you will, meaning our investors. And so if you look at Manulife and you listen to our CEO talking on the quarterly earnings calls, two things come up quickly as strategic priorities. One is doubling down on those high growth markets in Asia with the emerging middle class and how we serve that customer. And the second one is growing our investment management business, which has been a real success story taking those capabilities we have in the insurance companies and making them broadly available to outside investors. If that's going to work at all, there needs to be not a whiff of concern about favorable dealing, that it's everybody getting the same opportunity.

So we've really set up, I'll use the infrastructure equity example, that it's a team serving our investors and three of those investors happen to be John Hancock, Manulife Canada, Manulife Asia. And it's lovely that collectively they've committed $2 billion to each of our funds taking risk in the exact same assets with our other investors. And so are very much relying on this program to be successful for their own portfolio success. But they're also, they're paying fee, they're paying carry, they cover their share of the costs of the program and they have no say on investment selection. That is just the team that decides investment selection and the team decides investment selection the same for everybody. Everybody comes in together, everybody exits together, and the team has board approved, an exclusive on US infrastructure equity investing at Manulife. No other team does it. Anything has to be shown to this team if it even looks like it would qualify as infrastructure. So we really know that we have to take that concern off the table as really, an entry point to be successful at all.

Stewart: You make a good point because I worked for an asset management firm that was owned by an insurance company, and I do think that there is a bit of a, I don't know, something in the back of people's head that goes, "Well, I'm going to get picked over choices" or "They're going to take the best stuff and I'm going to get what's left," and so on and so forth. And there's a lot of rules, I mean, SEC rules around that sort of thing when an insurance company is being allocated alongside of third party client. As your client, I have to be treated no worse than your own internal account, your GA, right?

John: That's right. And we've been running this infrastructure equity program for 23 years in the US, but we only opened it up to outside investors in 2018. And that was just the entry point. It started with investment committee and board approval of here's all the possible ways that people could perceive conflict, and we're just going to take that off the table and it's very much also family hold back. If it looks like it's close, then it's outside investors do the thing that you know takes care of them first.

Stewart: So when you're thinking about infrastructure and the different segments, do you think about various infrastructure, sub-asset classes for various parts of your portfolio? How do you connect the asset classes back to the liabilities?

John: Yeah, really interesting question, Stewart. For us, we look to run a diversified book of infrastructure assets and there's a strong culture here of diversification is the one free lunch. But also I think importantly, the opportunity set is continuously evolving. So when I was getting started in 2001 here at Manulife, but also my prior career in banking, then we were investing in a lot of gas fired power plants to help America get off of coal at a time when that was 50% of the electricity supply was coal.

Today we have about as many natural gas fired power plants as we need to help that transition and America's down to 20% coal-fired power supply, so then renewables become important. And in 2007 when our debt program financed the first utility scale solar power plant in the United States, that was a brand new thing. Skylab in the 1970s, that had solar panels, but no one had done a utility scale solar park before, so you had to figure out what's the technology risk you're taking, and so, you get involved. We've been investing in geothermal since the 1970s, and then more opportunities came up around the GFC, but that resource can deplete, so how do you play that the right way? Solar was really expensive and then with a lot of investment became great value and is now lower cost than natural gas fired power if you look at solar at its best.

So the opportunity set keeps evolving and you need to be playing things that are probably similar to a lot of stuff you've done in the past, but they're never exactly the same. And so that's another reason that you focus on diversification so that you can go from utility scale solar to community solar to residential solar, that you can use your experience with 50 different utility regulatory environments state by state in the United States and figure out how to play new opportunities, look at incentives and tariffs that are different by region and come up with a good mix. And I'm using a lot of renewable energy transition examples, but the emergence of digital infrastructure assets as an infrastructure equity class in the last eight years, has been a tremendous opportunity, but you had to figure it out on that one what's right for our book because looking for investments where if it doesn't work out, you still get your money back, if you will. I mean, that's a classic part of the infrastructure resilience story.

So I'd say we're looking for things that we can hold over a long period if we need to. If it doesn't work out, we still get our money back. And what does that look like in renewable energy, digital infrastructure, transportation, utilities, social infrastructure? That's where we draw the boundaries.

Stewart: Talk to me a little bit about deal flow and why it matters in infrastructure, because my perception is that you need to be a player in this space to see deal flow and I mean a consistent player. You can't be in and out, in and out, in and out. So can you talk a little bit about deal flow and why it matters? And I'm talking your book a little bit here, but at the end of the day, I think it's real that if you want to buy infrastructure, you need to be with somebody who's buying infrastructure on a regular basis, right?

John: That's right, Stewart. We see that show up in our program repeatedly. And even 15 years ago, I was having managers who were partners with us say, "Because of your involvement in direct equity, fund equity, private debt, public debt, nobody sees the US market the way you do." And this is another infrastructure equity manager in whom we invest, but also raises for other parties. And if you look at our program over the years, including today, there's a lot of repeat business. A customer who was with us asking us to help them build transmission lines and then comes back and says, "Can we partner in JV together to build batteries that will help our market be resilient with more renewables coming in and weather swings?" And we see that with utilities with whom we've got a 15 year relationship, and then they want us to be a joint venture partner on either energy efficiency or renewable energy.

So we see a lot of repeat business and also that value of your reputation precedes you. We execute in a way that our partner will feel, if I had to do it again, I'd want to do it again with Manulife. One and done is a really tough way to lead your business. You have to always be the bid that nobody else can match. If you're going to leave people regretting it, it's much better to be all about repeat business and a good partner experience. And so for all those reasons, I think it's really helpful. And then just the precedent of is it 75 different portfolio companies in the equity program, 300-400 borrowers in the debt program. You just got a lot of precedent. So the new thing is not brand new for us. It's an evolution and there's a lot of stuff we can comp it to, which also helps with underwriting and portfolio performance.

Stewart: And I mean, it really gets down to, and this is something that we don't really touch on all that much in this show, but I think it's implicit with every one of our guests, which is this business is built on trust. Period, the end. This is a relationship business. Period, the end. And there's people who've been in this business a long time and insurance companies make long-term promises, and there's trust in that too. I mean, it is a trust business. And it's nice to hear that it works that way in renewables as well.

I want to talk with you a little bit about the Inflation Reduction Act, which one of our podcast guests referred to as the Energy Defense Act. So seems like there's a whole lot of tailwind and toward renewables. Someone said that it made the US the low cost provider of renewables. I don't know that. What can you tell me about the Inflation Reduction Act and how it impacts this market?

John: I'd say, Stewart, it's interesting. So the federal subsidy support for renewables has been intermittent. And so what is interesting to me is that before the Inflation Reduction Act was passed, already wind at its best, was lower delivered cost of electricity than natural gas fired power plants. And solar at its best, was lower cost than natural gas. So tremendous progress had been made. What I think the Inflation Reduction Act did was it was trying very hard to accelerate renewable energy installations and also make them economic in more parts of the United States. And so not just high cost areas on the coasts, but in the middle of the country, have renewable energy be an easier and easier yes as the low cost solution. And you see that the nature of the tax credits, but also some of the adders to specifically, for example, incent economic development around retired coal plants and various things to let every state in the union participate in the energy transition even if you don't have the wind of the planes or the sunlight of the Desert Southwest, renewable energy can still be a good answer for your community.

Stewart: That's really cool. I've learned a whole bunch today and I really appreciate you being on. I've got a couple fun questions for you on the way out the door if you'll have them.

John: Yeah.

Stewart: We have two. There's optionality. Most of our guests take both, no pressure. What is some of the best advice that you've gotten in your career to this point? And the second one is, who would you most like to have lunch with, alive or dead? How about that? Advice first.

John: Advice first was a colleague of mine who was a class ahead of me coming out of business school. I mentioned I went to Georgetown MBA to get some marketable skills to get into the private sector after government service. And he was a classmate a year head who looked at me and said, "Build skills." And that was a really neat advice for focusing on jobs where you're going to learn something. And I really like the definition of a good job is something where you're building skills, you're having impact, and you have agency on how you spend your time. That's a really good virtuous cycle. So if you can go to a space where you're going to have that, that probably means learning impact in a continuously positive way.

Stewart: Based on that, I've got a really good job. I feel good about that, John. Thank you.

John: Right? Yeah, exactly. And it shows. Our audience can't see your smile, but I can tell that that's a sincere comment.

Stewart: Thank you. Yeah, absolutely. And then how about who'd you most like to have lunch with?

John: I have someone in mind who has seen, up close and personal, both sides of the political polarization in the United States and also racial conflict in the United States. And they can't really speak openly because of the difficulty of getting elected with the whole truth and the partisan cycle. So I would love for them to have lunch with me if they knew that after the Men in Black neuralyzer would wipe my mind and they could just give me both sides of what they see and how they think about it. But I fear that unfortunately, that's not possible in the current climate. But I think on that, we just all be kind, listen to each other and listen to understand, not listen to convince. That's been some pretty good advice and maybe that's the journey a lot of us are on.

Stewart: Wow. I love that. Thank you so much. We've been joined today by John Anderson, Global Head of Corporate Finance and Infrastructure at Manulife Investment Management and John Hancock Life Insurance. John, thanks very much for taking the time. It's been a pleasure.

John: My pleasure. Thank you so much, Stewart.

1 Data as of September 30, 2023

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The views and opinions expressed in this podcast those of the speakers at the time of recording and are subject to change as market and other conditions warrant. This podcast is for informational purposes only and is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise, regarding any specific product or security.