The joys of going direct

Twenty-three percent. That was the return made by the Caisse de dépôt et placement du Québec’s (Caisse) infrastructure portfolio in 2011.

Yes, you read it right. It was not the Caisse’s private equity portfolio that returned that double-digit figure – in fact, the private equity portfolio returned a very modest and very infrastructure-like 7.1 percent. No, it was definitely the infrastructure portfolio that accomplished the feat.

To add to the chagrin of those already casting envious looks in the direction of that return, here’s an important aspect to note: the Caisse’s $6 billion infrastructure portfolio is almost entirely comprised of direct investments. This means that whatever value creation went into achieving those remarkable results was the sole work of the Canadian pension and its co-investment partners – no general partners were involved.

With the Caisse breaking so many perceived industry rules – extracting high double-digit returns out of an asset class usually associated with far more modest outcomes; and, by going direct, creating the sort of value that would shame many GPs – I feel comfortable springing the obvious question on Macky Tall, the Caisse’s infrastructure boss, before he even has time to add sugar to his freshly ordered coffee: “What exactly happened last year?”

“Our infrastructure programme is a long-term programme, so while we are pleased with the very good results of last year, what really matters is our performance over the long term and that’s what we’re most pleased about,” he starts. “It hasn’t been as spectacular as last year’s, but it’s been stable, robust and if you look at our track record over the past seven or eight years, we are pleased with that long-term record,” he adds.

Spoken like a true infrastructure investor. But still, what a year! Especially when you consider that, globally, 2011 did not give most investors much to crow about…

“There are a number of reasons behind last year’s success,” Tall elaborates. “The first and most significant is that the assets in the portfolio have performed well. Last year was a challenging year on a global, macro-economic level. We have a defensive portfolio and in that challenging year the entire portfolio of 17 or 18 investments grew its profits by 12 percent. So that gives you part of the explanation.”

He continues: “The portfolio’s cash yield was also at a very satisfactory level – that was the second element. And lastly, like in other real asset classes, interest rates have been very low. And in a low interest rate environment we have seen valuations for real estate and infrastructure go up as investors value the more stable nature of these investments.”

Of course, the rest of the Caisse's infrastructure success story lies in the quality of its portfolio and Tall, without revealing any trade secrets, claims as much:

“For example, last year, Enbridge Inc. – the largest liquid pipeline in North America and one of our largest portfolio positions, with some $900 million invested – had an exceptional year with its profits per share growing by more than 11 percent, its dividend per share growing in excess of 15 percent, and its share price recording 20 percent-plus growth, which, when combined with a strong single-digit increase in cash yield, helped produce these benefits.”


While last year’s results may have been exceptional, to borrow Tall's term, ‘exceptionality’ seems to be very much a part of the Caisse’s infrastructure path. After all, not many pensions can lay claim to a €6 billion portfolio made up almost entirely of direct investments. And of those pensions now extolling the virtues of going direct, most cannot say they started investing in infrastructure this way.

The Caisse can, however, since its very first infrastructure investment was 1999’s historic privatisation of Canada’s 407 ETR highway, undertaken with Spanish infrastructure developer Cintra, a subsidiary of BAA owner Ferrovial. In hindsight, what makes that first direct investment really interesting is that the Caisse never looked back.

“Our infrastructure allocation really began in earnest in 2003,” Tall reminisces. “That’s when we began to invest systematically and since 2003 we have probably deployed some $7 billion with a few exits in between. Looking at our performance since 2003, we have actually done better than our [internal] targets,” he adds.

And you never once thought of using funds, during all this time?

“I think funds have a role to play, they create value and give access to infrastructure for people who don’t have certain capabilities. So we understand the role of funds and I think they are here to stay and will continue to grow,” he diplomatically begins.

“However, in our case, and when it comes to infrastructure, our strategy has allowed us to actually successfully develop an interesting portfolio, with assets that fit closely to our risk/return appetite. So we don’t feel the need to go down the fund route when the direct route has provided us with what we need,” he concludes.


Part of the reason for this direct approach surely lies in Tall’s robust infrastructure background prior to joining the Canadian pension.

“I began my infrastructure career a bit over 20 years ago, doing structured project finance – so I started on the lender side of the business, which gave me a good understanding of the asset class’s fundamentals,” he explains.

“But I was also involved with energy projects – power generation, among other things – and the process of making investment decisions and understanding the fundamentals of developing projects. So ultimately, those experiences of working in structured project finance and developing energy projects for several companies provided me with a background of experience which is very helpful today in being able to try and run the Caisse’s infrastructure programme efficiently,” Tall adds.

Unsurprisingly, taking the road less travelled hasn’t been without difficulty:

“The direct route is very challenging. It requires a lot of effort and is becoming increasingly competitive, but we remain determined to keep to that route because the results have been there. We have a portfolio that has just gone through some challenging years and we are reassured by its quality. Our approach is correct and we intend to stick with it.”


But what exactly is the Caisse’s approach, considering it is generating the sort of returns that imply a fair degree of asset management expertise?

“We usually don't go for the controlling stake [in the companies we acquire]. Our sweet spot has generally been to acquire a strong minority position with governance. So, in that sense, we don’t look to be the ones running the business day-to-day – we aren’t equipped for that – but rather to have a position where we are involved in the major decisions, the strategic decisions and the value-creating decisions,” Tall says.

“We let the management team or a strong strategic partner take care of the day-to-day – but obviously following the direction which has been agreed by the shareholders. That’s what we look for,” he adds.

Naturally, the Caisse’s involvement fluctuates according to circumstance. “The level of intensity varies. If there comes a time when a major capex [capital expenditure] decision has to be made, if there is a major refinancing or regulatory challenge, then our involvement will become more intense to make sure decisions are consistent,” Tall explains.

Incidentally, the Caisse’s head of infrastructure is not shy about capex – somewhat contradicting the popular image of the direct institutional investor, single-mindedly obsessed with yield – despite the short-term impact these deployments might have on an asset’s yield.

“If you take an asset like BAA, which has improved significantly for us since the initial investment, we have to deploy around £1 billion a year in capex. And why is that? Because the demand is there for passengers and volume increases and we have to keep improving the quality of services. So while this capex can affect the dividend flow these are long-term investments which can generate revenue and dividend in the long-term,” Tall insists.

Still, while not afraid of capex, the Caisse prefers to stay away from big capital-intensive projects, which means keeping clear of greenfield projects.

“There are no absolute ‘no-go’s’, but there are areas in infrastructure we don’t like as much, including greenfield risk. We have taken greenfield risk on a very limited basis and these projects remain a very small portion of the portfolio,” Tall states.

Tall, betraying the Caisse’s institutional investor nature, is predictably not a big fan of “very aggressive business plans where there are expectations of a very high growth rate over a long period of time. Our experience is that those returns sometimes materialise and sometimes don’t,” he notes dryly.

“We are also not big fans of leverage, historically, and the global financial crisis has confirmed to us that leverage has to be used in a reasonable way. Leverage is good, but it has to be used in a prudent way as excessive leverage can actually damage the qualities we seek in infrastructure and an asset’s risk/return profile,” Tall argues.

Tall is also in no hurry to get the Caisse’s cheque book out. “We don’t have a set number of deals we have to do in a year, and that’s part of our disciplined approach to investing. We have a growing infrastructure programme and we are trying to continue to meet the demand from our investors to get more exposure to infrastructure but at the same time, if we don’t find the right investments that meet our criteria, we will not invest.”

“So if we do one quality deal we are pleased and, if we do three, that’s even better. What we don’t want to do is just one bad deal – or three,” he concludes, laughing.


Make no mistake though, regardless of pace, the Caisse is steadily growing its infrastructure portfolio. In fact, while the Canadian pension might already boast one of the world’s largest infrastructure portfolios, “in relative terms it is still a small proportion of the Caisse’s asset base, representing about 3.8 percent of the total portfolio,” Tall points out.

“Because of the fundamental characteristics of infrastructure – inflation protection, stable long-term cash yields – it is a natural match for the long-term liabilities of our customers. And since we have a good track record, there is a desire to grow the infrastructure portfolio in the coming years to above 5 percent,” he says.

In practice, that means two things: one – prospective job-seekers take note – the Caisse will have to grow its infrastructure team; and two, that the pension will start moving out of its comfort zone to invest in new markets, including emerging markets.

“Our 12-person team today manages some $6 billion spread over just under 20 investments. But we intend to do a couple of things over the coming months, the first of which is to increase the team’s size to closer to 18 people and strengthen its asset management capability,” Tall reveals.

While he won’t change his asset management approach, Tall explains the Caisse has “a number of large investments in Europe, so our intention is to locate some asset management capability in Europe, close to the investments we have and our partners”.


The other side to the Caisse’s expansion plans is that it will have to start looking outside of its traditional markets for growth. In a way, that expansion has already begun, with the pension’s recent joint venture with Australian developer Plenary Group to invest in public-private partnership projects Down Under being a prime example. But La Caisse’s future, in contrast with its past, will not solely be confined to developed economies.

“If you look at our portfolio today, the majority of the investments are in Europe with the balance in North America. We certainly have an appetite to invest more in North America and Canada, which are markets we know very well and which we think will offer more opportunities over the coming years,” Tall offers.

“But the economic consensus is that OECD countries will have relatively low growth over the coming years, with most of the growth to be located in emerging countries. As a consequence, we are currently developing a strategy on how to play the emerging market opportunity from an infrastructure point of view,” he explains.

That, of course, poses its own very specific set of challenges, especially when you take into account that the Caisse is a direct investor. Predictably, Tall isn't rushing headlong into emerging markets.

“We plan a very limited approach in terms of sectors and also a limited number of emerging countries,” Tall says. “We are thinking about the best way to adapt our investment model to the emerging market opportunity, because, obviously, while the sectors are the same, we understand the risk/return profile of infrastructure in emerging markets is different and we have to take those factors into account and properly determine the risk/return profile for these emerging markets.”

“Clearly, one of the ways to mitigate the risks of emerging countries is to partner with someone who knows the local market really well – and that can be either a strong local partner or it could be a more global partner who has been in the country for many years, has a track record and knows the particularities of specific markets really well,” he adds.

With a best-in-class infrastructure portfolio under his belt and a desire to grow in what is still a relatively young asset class, Tall is understandably optimistic about the future:

“Infrastructure is currently at an infancy stage – but an interesting infancy stage – and will continue to mature. I regularly run into institutional investors who want to develop an allocation in the space and those who are already active are interested in increasing their allocations. So when you combine these elements with governments on the other side who are eager to cut spending, I think the fundamentals are there. Yes, it will take some time in some specific circumstances and political contexts, but growth is forthcoming.”