Jack McGougan joined AustralianSuper just before the 2008 crisis. He talks to Florence Chong about pruning its property portfolio and taking it direct
When Jack McGougan joined AustralianSuper, it was hardly an auspicious time to establish a property team for the fast-growing industry superannuation fund. It was 2008, and the world was about to be engulfed by the global financial crisis.
McGougan was also faced with the AUD3.6bn (€2.5bn) of existing property investments. As McGougan recalls, it was a portfolio that needed pruning. It included investments in no less than 50 property funds. The funds were closed-ended, highly-geared, exposed to development projects, illiquid and suffering from poor performance.
To be fair, McGougan says, AustralianSuper had grown through a number of mergers with smaller funds and its property portfolio had inherited some baggage along the way.
The problem was apparent to AustralianSuper’s CIO, Mark Delaney. He could see that the scattering of assets would get worse as the fund grew, so he turned to his former National Mutual colleague, McGougan, to give the fund’s property holdings the leadership role needed.
Unlike other super funds, AustralianSuper had long recognised the importance of alternatives, such as property, infrastructure and debt. Because it was in an accumulation phase until about 2035, the fund’s vision had to be for the long term.
Today, AustralianSuper is the largest industry fund in Australia. It manages AUD104bn in assets, which grow at about AUD6bn a year.
McGougan was already a veteran property fund manager when he joined AustralianSuper. He ran one of Australia’s best-known property funds, Cities of Australia, after it was delisted, and stayed with the fund for over 15 years – moving with it to new owners – National Mutual, then AXA, then to the asset management arm of Deutsche Bank.
He took up Delaney’s challenge – and what a challenge it was. McGougan says that, in his first year (to June 2009), property returns at AustralianSuper came in at a humbling -20%. “That shouldn’t happen in a property portfolio,” he says, shaking his head in disbelief.
The portfolio revamp is now coming to an end, he says, with a few residual parcels of secondaries to be offloaded before AustralianSuper exits its final legacy investments. So far, it has raised AUD1bn from the sale of secondaries.
The conundrum McGougan faced led to the genesis of what has been a wholesale change in the fund’s property investment strategy. The crux of the new strategy is a focus on direct investment, to reduce leverage, and to de-risk by investing only in core assets.
The strategy has reduced the management expense ratio from 67bps to 45bps – and lifted returns.
AustralianSuper began rolling out its new direct property strategy in 2014, and has since whittled down its Australian property holdings to those associated with two fund managers: ISPT, a Melbourne-based fund manager owned by industry super funds; and the Queensland state-owned QIC.
Overseas, AustralianSuper has appointed TH Real Estate to spot investment opportunities in the UK. And its US mandates have gone to QIC for retail, to Principal Real Estate Investors for commercial, and to Sentinel Real Estate Corp for multi-family. Last year, the fund added the Canadian firm, Bentall Kennedy, to its mandate list to pursue core retail and office acquisitions, predominantly in Vancouver and Toronto.
“Our focus is to invest more directly, and to seek more control of the investment,” McGougan says. “The opportunities weren’t presenting in Australia. So we took the opportunity to look offshore. In essence, our direct investment strategy actually manifests itself offshore rather than here. It is just a timing issue. If major new investments come up in Australia, we will be doing those directly as well. But now is not the right time in the cycle.”
Long-term London landlord
AustralianSuper’s largest single investment is in London, where it has increased its stake in a 67-acre urban renewal project in London’s King’s Cross from 25% (in 2015) to 67.5%. In January 2016, the fund paid AUD900m for a stake owned by the British government, giving it majority control. AustralianSuper has, so far, invested AUD1.4bn in King’s Cross. The project is due for completion in 2021, with an estimated end-value of AUD5bn.
“That is a very long-term investment for us,” says McGougan. “The whole rationale is to give us meaningful exposure to the London office market. Although it is a mixed-use estate, it is predominantly the office component that we are targeting.”
Talk of the London office market today often ends up with discussions about Brexit. Is he concerned that the super fund may now be exposed to Brexit fallout?
“Brexit was a great shock to most people, and it shocked me,” McGougan concedes. But, on reflection, concerns about potential ramifications have evaporated, he says. “If you strip out a lot of conjecture and different views, the reality is that no-one knows what the impact of Brexit will be.”
McGougan is, however, unflinching in his faith in the fundamentals of the London office market, and is heartened that office occupiers are continuing to commit to space.
“In retrospect, we still would have made the investment, irrespective of whether Brexit would occur or not, because it is the right asset in the right market,” he says. “If you think it through, we have a good prism [through which to view] the London office market [in] King’s Cross. It is a mixed-use development, predominantly office. Google is taking space – a great endorsement, not only of the London market but of the estate itself.
“King’s Cross is a good microcosm of the market. Different parts of London will be affected differently. Canary Wharf, for example, has more commodity-style office accommo-dation, and there you can see the opportunity perhaps for some users to relocate.”
King’s Cross has become, he adds, almost a substitute for the London’s West End, attracting tech companies and other West End-type tenants, such as Universal Music. There are very few financial services companies taking space.
”In essence, our direct investment strategy actually manifests itself offshore rather than here. It is just a timing issue. If major new investments come up in Australia, we will be doing those directly as well”
“Office users have to make decisions today. They can’t wait for 12 months or two years to see what might happen. By and large, office users still see London as their core office location.”
McGougan says it makes “enormous sense” from an occupiers’ point of view to be in London because it offers “enormous benefits – benefits not available in European cities, such as Frankfurt or Paris”.
And King’s Cross, he says, is on a transportation hub linking London to continental Europe.
McGougan had already “uncovered” the Kings Cross project before TH Real Estate brought AusralianSuper into the King’s Cross Central Limited Partnership, the consortium behind the massive redevelopment project, in 2015.
AustralianSuper is also jointly invested with Hermes Investment in a shopping centre development, centre.mk, in Milton Keynes, a city north-west of London. It acquired Prudential’s 50% interest there for £270m (€323m) in 2013. In January, the partners announced a £60m investment plan for development.
AustralianSuper, which is in the process of awarding a new mandate, has struggled to make any further big investments in Europe, says McGougan. “The sort of assets we are targeting are north of US$500m (€466m), so there are not a lot of opportunities. We have to be patient, and we will continue to monitor the market.”
Fortune favours the brave
In contrast, the US has been a fruitful destination. “When we first started in the US, there was some reticence and caution. The Americans wondered if we could execute,” says McGougan.
Today, AustralianSuper owns offices and a stake in what is billed as the world’s largest open-air shopping centre, Ala Moana, in Honolulu. Soon, it will add multifamily projects to its US holdings.
“We have just paid the second tranche on the [Hawaii] shopping centre,” McGougan says. The fund bought a 25% holding in the shopping mall in 2015 for US$1.2bn from General Growth Properties.
McGougan admits the decision to give QIC, an Australian investment manager, its US retail mandate “seemed unusual”. But, he says, “if you see the scale that QIC is developing in the US, they were the right choice there for us”.
QIC is increasing its US footprint, with plans to take full control of 11 regional malls in Forest City Realty Trust, a US$4bn fund it co-owns with New York-listed Forest City Enterprises.
Through Principal, AustralianSuper has entered a joint venture with Brookfield Property Partners, taking a 49% equity stake in an eight-office portfolio in Washington DC for US$349m.
While negotiating that acquisition, McGougan learned that Brookfield was selling a stake in its office tower in Boston. AustralianSuper bought a 49% holding in the building, 75 State Street, for US$145m.
McGougan expects to close the fund’s first multifamily housing transaction soon. “We are interested in multifamily-style investment in all the markets and geographies we are in,” he says. “The sector is most established in the US, where it is absolutely an institutional class asset.
“We like the characteristics of this sector – there is underlying growth and strong demand from a mobile workforce.”
McGougan says the fund is “currently assessing two transactions with Sentinel”. When asked about the expected purchase price, he says: “The minimum size of a US multifamily project is around AUD75m. Project values can range up to US$150m.”
And about what a Donald Trump administration means for real estate in the country, McGougan says: “You have to look beyond the headlines. Everyone is suggesting some sort of reflation with the sort of policies that he has mooted.
“But it is more what is happening in micro markets that interests us. If you look at the economies we’re investing in – or are invested in – they are all countries that are growing at a slower rate than some developing markets.
“These micro markets have been underpinning their economies. Growth might be just 2% per annum within that environment, but we can still find good opportunities. So we don’t get too hung up about the macro issues – although we can’t ignore them completely.”
Tyranny of distance
AustralianSuper’s real estate assets are about AUD10bn, with AUD1.7bn in the UK and AUD1.9bn in the US. “If you were to characterise what we’ve bought so far – it is all close to how we scripted it,” says McGougan.
As for the tyranny of distance: “We are very active asset managers. We get very close to our assets and have a keen influence on what happens.”
McGougan himself visits his projects in London seven or eight times a year, and he has appointed two employees from Australian-Super’s infrastructure and property teams to a new office there.
“We have continued to provide members with good returns, particularly having regard to the fact that we have grown the fund so much – and have made many large acquisitions.”
The size of the portfolio has increased by 40% in the past few years. “Normally that [rate of growth] is very dilutive of returns, yet we have actually been able to maintain very healthy returns to our 2m-plus members.”
As for risks on the horizon, McGougan says: “You have no control over markets. The best mitigant is investing in the best property you can find. We have done that. To the extent that you can insulate yourself against market movements, we have done what you can do. If interest rates increase exponentially, all asset classes are going to be affected, and property will be as well.”
What keeps him awake at night? “Essendon,” he jokes, referring to his favourite Melbourne Aussie Rules football team, and how it might perform this season.
Mid-risk: a new asset class?
In a capital-abundant world where assets are keenly fought over, how does a superannuation fund keep its bases covered? Create a new asset class and call it ‘mid-risk’.
AustralianSuper restructured in December to include a specific mid-risk unit. It is headed by Jason Peasley, former head of infrastructure, to straddle property, infrastructure, higher-yielding credits and subordinated debt.
Nik Kemp, AustralianSuper’s head of infrastructure, explains that mid-risk has come into being to bridge the gap between high risk (equities, private equities, growth assets) and low risk (cash and bonds).
He gives the hypothetical example of having to make a choice between buying an office building in Washington DC or a regulated electricity distributor in Sydney.
He says: “Which is a better deal?” It is a difficult decision to make when both assets offer a similar expected return. Bringing together the infrastructure, property and higher-yielding debt teams together should help.
Following the restructure, AustralianSuper hopes to avoid missing out on opportunities that come to market “just because we have a narrow focus on what is infrastructure, property or debt”, Kemp says. “We can look at, frankly, anything, from a whole group perspective, whether the capital comes out of infrastructure, property or something else.”
Kemp says that, as core infrastructure assets have become more expensive, AustralianSuper has turned to infrastructure subordinated debt to maintain its presence in the sector.
So far, it has invested several hundred million dollars in infrastructure assets in Europe. That is a mere drop in the ocean compared with its AUD12bn global infrastructure portfolio of airports, ports, water utilities, and energy transmission assets in Australia and offshore.
Kemp says pricing has becom ing a challenge – and that it will remain so because of the volume of global capital chasing core infrastructure assets.
He says there was more than three times the capital required lined up to bid for TransGrid, owner of Australia’s largest high-voltage transmission network, which sold for AUD10bn in 2015.
In December, AustralianSuper and its partner, IFM Investors, settled on the latest acquisition, a 50.4% share in AusGrid, Australia’s largest electricity transmission system, for AUD16.2bn – the highest price yet paid for a piece of infrastructure in Australia.
“Obviously things are very expensive today, particularly in the core sector,” Kemp says. “So we are probably looking to invest right across a project’s capital structure. That means we look at the universe – from infrastructure equity to subordinated debt and senior debt.
“This is the one advantage we have versus others – flexibility to invest across the capital structure.”
Kemp is aware that many groups have raised a lot of capital to invest in infrastructure, and that some of that capital will flow into different parts of the capital structure.
The likes of Brookfield and Global Infrastructure Partners already invest in infrastructure debt, he says. “But that space is not quite as crowded as the core equity space. We typically play above the senior debt space. Having said that, our fixed-income colleagues have senior infrastructure debt in their portfolio.”
Kemp says debt can be for greenfield or brownfield projects, and that a decision to participate is influenced by underlying risk. “At the end of the day, we are looking for good returns,” he says.
Asked if he is keeping a closer watch on the US now that the government is talking up infrastructure investment, Kemp says: “The thing with all jurisdictions is that, often, a lot of the assets that are being developed or sold are actually held at the state and local government level.
“It is great to have [President Donald] Trump and the Federal Government planning to increase the pipeline of potential opportunities, but you need the states to get on board as well.
“Certainly, in the US, you see more states, like Indiana, embracing privatisation a bit more. But many other states are still relatively closed to the idea.”
In general, he notes that US states are not “in that phase of evolution of capital recycling that we are seeing here in Australia”.
He says: “In summary, I would say the noise is great. But it won’t be until you start seeing it filter down through the different layers of bureaucracy or government that things might take off.”