Infrastructure and Long-Term Investing July 2013 Peng Chen, PhD, CFA, Chief Executive Officer & Portfolio Manager, Asia ex Japan, Chairman, Dimensional SmartNest
Agenda 1. Who is Dimensional 2. Defining Infrastructure 3. Historical Risk and Returns 4. Infrastructure and Long Term Portfolio 5. Return and Cost of Capital of Regulated Infrastructure 6. Methods and Inputs for Calculating Cost of capital 7. Summary 34453_072013
Who is Dimensional 34453_072013
Global Investment Team, One Dynamic Process Fully integrated portfolio management Portfolio Management Founded in 1981 Client Service Amsterdam London Berlin Vancouver Tokyo Santa Monica Austin Singapore $283B in global AUM Sydney 715 employees globally Dimensional Fund Advisors LP founded in 1981. Global AUM and number of employees as of March 31, 2013. Locations with offices operated by Dimensional. “Dimensional” refers to the Dimensional entities generally, rather than to on e particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., and Dimensional Japan Ltd. 34453_072013 3
Closely Affiliated with Leading Academics Deep working relationships benefit Dimensional’s solutions and investors Academic Members of the US Mutual Fund Investment Policy Committee Board of Directors Kenneth R. French, Chairman George M. Constantinides Tuck School of Business Booth School of Business Dartmouth College University of Chicago Eugene F. Fama John P. Gould Booth School of Business Booth School of Business University of Chicago University of Chicago Robert C. Merton, Nobel Laureate Roger G. Ibbotson Sloan School of Management Yale School of Management Massachusetts Institute of Technology Yale University Edward P. Lazear Graduate School of Business Stanford University Myron S. Scholes, Nobel Laureate Graduate School of Business Stanford University Abbie J. Smith Booth School of Business University of Chicago 34453_072013 4
Dimensional Global Investment Solutions $283 billion in global AUM as of March 31, 2013 (in billions) US $83.0 Non-US Developed $70.0 Emerging Markets $56.8 All Cap Core $24.7 All Cap Core $16.8 All Cap Core $15.6 All Cap Value $3.8 All Cap Value $5.6 Value $29.9 Large Cap Value $13.4 Large Cap Value $18.8 Large Cap $7.4 Large Cap $4.8 Large Cap $5.4 Small Cap $3.9 SMID Cap Value $7.9 SMID Cap Value $0.9 Small Cap Value $13.1 Small Cap Value $11.3 Small Cap $10.6 Small Cap $11.3 Micro Cap $4.6 Fixed Income $59.3 Global Equity $5.9 Non-US US Taxable $31.9 All Cap $5.9 US Developed Equities US Tax-Exempt $2.3 Equities 29% 25% Non-US & Global $22.2 Other $7.9 Other Inflation-Protected $2.9 Emerging Real Estate $7.0 3% Fixed Markets Commodities $0.6 Income 20% Global 21% Global Asset Allocation 1 $6.2 Equity 2% “Dimensional” refers to the Dimensional entities generally, rather than to one particular entity. These companies are Dimensi onal Fund Advisors LP, Dimensional Fund Advisors Ltd., DFA Australia Limited, and Dimensional Fund Advisors Canada ULC. 1. Global asset allocation assets are for information only; these assets are primarily an aggregate of underlying funds and are not counted in totals. All assets in US dollars. Numbers may not total 100% due to rounding. 34453_072013 5
Defining Infrastructure 34453_072013
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Infrastructure Essential physical assets, facilities, and systems that enable society to function. It includes • Transportation (roads, bridges, tunnels, airports, railroads, ports, etc.), • Energy and utilities (power generation, fuels, water systems, etc.), • Communication (line-based networks, air-based networks), • Social (schools, hospitals, prisons, other public buildings) assets of society. These are long-lived, real assets that are costly and time-consuming to replace, often without immediate substitutes, that typically generate relatively stable cash flows that increase with inflation. 34453_072013 8
Is Infrastructure an Asset Class? Criterion for An Asset Class • Logical grouping of assets that share similar characteristics • Collectively have an inherent, non-skill-based return (Beta, not Alpha) • Unique risk and return characteristics and non-overlapping with other asset classes • Investable Infrastructure • Stable cash flows: usage does not materially decline with price increases or during periods of economic weakness • Long-term returns: governments allow private owners to earn fair returns in order to incentivize them to keep facilities in good working order • Inflation protection: the ability to increase rates linked to inflation over time 34453_072013 9
Is Infrastructure an Asset Class Source: EIA, J.P. Morgan 34453_072013 10
Is Infrastructure an Asset Class Source: EIA, J.P. Morgan 34453_072013 11
Ways of Investing in Infrastructure • Direct ownership – control, but concentrated risks • Private Equity Funds/Partnerships – more diversified • Listed Infrastructure Vehicles – Traded on an exchange, – Liquid, and have extensive financial reporting requirements regulated by the various stock exchanges 34453_072013 12
Historical Risk and Return 34453_072013
Various Index that Tracks Infrastructure Industry Breakdowns Source: Dow Jones, FTSE, MSCI, S&P, UBS *Estimate 34453_072013 14
Various Index that Tracks Infrastructure Geographical Exposures Source: Dow Jones, FTSE, S&P, UBS Source: Ibbotson Associates. 34453_072013 15
Historical Performance Benchmark Historical Risk and Return Characteristics (June 30, 2013) MSCI AC World UBS Global UBS World S&P Global Infrastructure Sector Infrastructure & Infrastructure & Infrastructure - Total Capped - Total Return Utilities 50-50 - Utilities - Total Return Index Index Total Return Index Return Index S&P 500 Inception Nov-01 Jan-99 Jan-95 Jan-06 Jan-26 Return (%) 1 Year 11.69 12.91 14.67 8.64 20.60 3 Year 10.39 12.64 12.28 9.10 18.45 5 Year 1.84 4.09 1.20 -0.77 7.01 7 Year 4.12 5.96 4.87 4.56 5.66 10 Year 9.67 9.17 10.79 NA 7.30 Inception 8.72 5.18 7.56 5.20 9.95 Risk (STD %) 1 Year 8.24 8.97 12.12 11.38 6.74 3 Year 10.07 9.28 13.94 12.98 13.56 5 Year 14.86 12.45 18.58 16.54 18.42 7 Year 14.45 12.61 17.67 16.19 16.71 10 Year 13.57 11.45 16.56 NA 14.58 Inception 13.51 11.62 14.89 15.91 19.02 Source: Ibbotson Associates. 34453_072013 16
Infrastructure and Other Asset Classes Returns-Based Style Analysis of Infrastructure Source: Morningstar EnCorr Source: Ibbotson Associates. 34453_072013 17
Risk Return Trade Off CAPM Expected Returns Risk Estimate Risk Free Beta Relative US Stocks CAPM Return (Standard Asset Class Risk-Free Rate to US Stocks Risk Premium Estimate Deviation) Cash 3.38% + -0.01 x 5.95% = 3.30% 0.89% U.S. Bonds 3.38% + 0.03 x 5.95% = 3.54% 4.36% Non-U.S. Bonds 3.38% + 0.24 x 5.95% = 4.81% 10.47% 3.38% + 0.46 x 5.95% = 6.11% 12.77% Global High Yield U.S. Stocks 3.38% + 1 x 5.95% = 9.33% 20.18% Non-U.S. Developed Stocks 3.38% + 1.26 x 5.95% = 10.88% 22.05% Emerging Stocks 3.38% + 1.46 x 5.95% = 12.06% 35.93% Global Real Estate 3.38% + 1.16 x 5.95% = 10.27% 23.04% Commodity Futures 3.38% + -0.03 x 5.95% = 3.18% 18.48% Global Private Equity 3.38% + 1.5 x 5.95% = 12.31% 39.89% Infrastructure 3.38% + 0.84 x 5.95% = 8.35% 18.70% Source: Author’s own estimate and Ibbotson Associates. 34453_072013 18
Efficient Frontier Asset Allocation Source: Ibbotson Associates. 34453_072013 19
Return and Cost of Capital of Regulated Infrastructure 34453_072013
Return and Cost of Capital • Regulated Utility’s return is closely tied to the target cost capital set by regulators • Long-term forecasts 5 Methods of Estimating Cost of Capital 1) The build-up method 2) Discounted Cash Flow Model (single stage and multi stage model) 3) Capital Asset Pricing Model (CAPM) 4) Modified CAPM model 5) Fama French 3 Factor Model 34453_072013 21
Build-up Method Small Cap Cost of Equity = Risk-Free Rate + Market Risk Premium Premium +Firm Size Premium + Industry Premium +potentially other factors U.S. U.S. Default Equity Risk Equity Risk Premium Premium Premium Horizon Horizon Horizon Horizon Premium Premium Premium Premium Real Real Real Real Real Risk-Free Risk-Free Risk-Free Risk-Free Risk-Free Rate Rate Rate Rate Rate Expected Expected Expected Expected Expected Inflation Inflation Inflation Inflation Inflation LT Small Large Treasury LT Cap Treasury Cap Bills Corporate Bonds Stocks Stocks Bonds 34453_072013
Estimating Cost of Capital • Discounted Cash Flow Model (single stage) • CAPM • Fama and French 34453_072013 23
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