Monday, 31 December 2012

RBF: A hard road ahead

All super funds have made bad investments.

RBF is certainly no exception.

The Hobart Airport investment via Tasmanian Gateway Consortium (TGC) was a classic example, predicated on the assumption that the good times would last forever as per Macquarie Bank’s crystal ball.

Macquarie came to town as part of Operation Stealing Candy from a Baby HERE  and sweet talked RBF into parting with $100 million for a non controlling minority interest in an airport at nearly twice the going rate at 27 times earnings, which necessitated a high degree of leverage to achieve the required return, which in turn led to the fixing of interest rates, ostensibly to placate nervous financiers but realistically designed to lock in returns for lenders, which together with a management fee which approximated 15% of earnings for a bit of paper shuffling and a couple of long lunches with bankers, ended up removing all the investors’ gains.

RBF should have been extracting steady rents from the deal. It was in a good position as a cashed up fund with implicit State Government backing.

Instead it became the perfect partner for the financiers and deal makers as the latter locked in their returns ahead of RBF who ended up with an empty promise of blue sky.

Had RBF been unwilling, it would have been daylight robbery.

But there was worse. At the same time as it decided on its airport investment in late 2007 RBF also paid $70 million to take up a share in a retirement village operation run jointly by Macquarie Bank and FKP, a listed property manager and developer.

The RVG investment is included in the asset class ‘property’. The airport is part of the asset class termed ‘alternative’.

Fellow shareholders, mostly industry funds, soon regretted investing in the over leveraged fund with overrated assets set up by Macquarie just before the bubble burst.

On August 26 2010 Florence Chong in The Australian wrote:

Disgruntled investors are canvassing sacking Macquarie Group as manager of Australia's second-biggest retirement village operator.

This comes after seeing the value of their holdings halve in the past three years.

The mostly large super fund investors in the unlisted Retirement Village Group -- a Macquarie Group-FKP joint venture -- are looking at options, including replacing Macquarie as the responsible entity and seeking damages from RVG for their losses, according to industry sources.

The dozen or so offshore and local institutional investors, who invested $850 million in RVG, have suffered substantial paper loss since the fund's inception in December 2007.

Macquarie and the Queensland-based FKP Ltd set up RVG in 2005 with the Zig Inge portfolio, bought at the market's peak in 2007 for $641m.

The Zig Inge purchase doubled its asset base. RVG's seed asset was the former Metlifecare portfolio. The group is the largest Trans-Tasman retirement village company.

Investors' frustration spilt into the public arena in February last year when its two largest investors, Retail Employees Superannuation and Hostplus (the hospitality and tourism industry's super fund), filed a claim the Federal Court in Melbourne against RVG "over the acquisition of the Zig Inge Group".

The case, initially heard in July last year, was finalised and dismissed by consent in February this year, according to court records.

The key issues in the RGV saga revolve around debt and financial engineering, including foreign exchange hedging. The trust is believed to be 50 per cent geared.

The Zig Inge acquisition was reported in 2007 to be 100 per cent debt funded.

"There seems to be some traction among some investors to have Macquarie removed as the RE (responsible entity)," said a Melbourne-based industry fund portfolio manager.

REST is understood to be the single-largest investor with about 20 per cent, and Hostplus holds about 15 per cent. The balance is held by 10 to 13 mostly industry super funds.

“I am not fond of the Macquarie model (of high leverage and financial engineering), but we all went into this vehicle with our eyes open."

FKP became the sole manager of RVG in January 2012 after it purchased Macquarie’s interest in the management entity.

FKP still owns 21.5% worth $65.7 million of RVG.

Although FKP only owns a minority interest in RVG, it is required to equity account for the investment as if it were majority owned because it controls the investment.

This means that FKP’s share of RVG’s assets, liabilities, revenue and losses are disclosed in FKP’s annual financials.

RBF’s interest in RVG is listed as being worth $31.1 million.

This implies RBF’s share of RVG is about 10%.

The figures in FKP’s financials suggests RVG’s assets at 30th June 2012 were $1,740 million, its liabilities $1,420 leaving it with equity of only $320 million. Revenue for the 2011/12 year was $34 million and losses totalled $275 million, most of which would have been asset write downs.

RBF’s investment in RVG was listed with a value of $72.2 million at 30th June 2008, but by 30th June 2012 the value had plummeted to $31.1 million, a staggering 57% fall.

It is believed RBF is yet to receive any income from RVG as all spare cash has been used to reduce liabilities.

At 30th June 2012 RBF had total funds under management (FUM) of $3,941 million.

RBF’s corporate plan looks in complete disarray.

FUM of $6 billion in 3 year’s time appears a forlorn hope.

The corporate plan is to increase new funds inflow by $300 million each year by 2015, on a year on year basis, but the latest year 2011/12 saw a decrease in the rate of new funds inflows of $56 million. New funds inflows (net of transfer out) in 2010/11 were $178 million. A year later the figure was $122 million.

Partnering the State government to reduce the defined benefit (DB) unfunded liability is no longer required as the Government abandoned that fiscal strategy in the last Budget.

Actively managing the DB plan assets, the funded portion of $1.4 billion or 40% of total FUM, to assist with reducing the unfunded liability will be difficult given the DB plan is cash flow negative as contributions by current members and Government payments to cover past unfunded liabilities are all immediately used to pay benefits.

It will be doubly difficult as property represents 16% of the DB scheme assets and alternative investments a further 20%. Actively managing illiquid assets like RVG and TGC will be challenging.

The accumulation scheme which represents 60% of FUM only had a positive cash flow of $80 million for the year as both employer and member contributions fell and transfers out exceeded transfers in.

Investment strategies vary depending on the cash flow status of a scheme. A DB scheme with a negative cash flow where membership is closed and all members are over 40 years old and many in pension stage will have a different strategy to an accumulation scheme with younger members, a positive cash flow driven by the 9% superannuation levy, and no loss of members.

But an accumulation scheme with a poor cash inflow, made worse by a reduction in members as occurred in 2011/12, will struggle to rebalance its portfolio in the post GFC world without having to sell its more poorly performing assets which inevitably will be very illiquid.

RBF’s infatuation with Macquarie Bank is likely at an end, given its unfortunate experiences with airports and retirement villages. It has been a harsh lesson.

RBF is in a bind.

If it says too much publicly it might frighten the horses.

However failing to update the value of the Airport investment in the list of investments in the latest Annual Report when the write down was almost 50% seems an incredible oversight. Having to find it buried in Volume 2 of Report of the Auditor General No.6 of 2012-13 is hardly adequate disclosure and full discharge of fiduciary responsibilities to members.

The Auditor General was moved to make a comment on page 12 of his report that the significant write down of the airport investment " highlighted the need for improvement in policies around investment decisions and monitoring".

No doubt the same comment applied to RVG.

Retaining the trust of members is crucial to increasing net inflows each year which in turn is crucial to running a healthy fund.

RBF’s commendable record over time is becoming tarnished.

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