The road not taken

When the $162 billion Canada Pension Plan Investment Board (CPPIB) embarked on an infrastructure investment strategy in 2006 it had two options, recalls Alain Carrier, CPPIB’s head of global infrastructure as well as head of private investments in Europe. It had to choose between an active or passive approach to investing in the asset class. The latter option turned out to be what Carrier describes as “the road not taken”.

Had the decision gone the other way, it’s unlikely that Carrier would have ended up sitting – as he is now – in the boardroom of CPPIB’s London office overlooking the leafy Portman Square.

After all, Carrier had built a career of some repute prior to joining the Canadian pension in January 2008. The culmination of 17 years in the financial industry up to that point had been a spell at Goldman Sachs where he had worked on major telecom deals such as NTL’s merger with Telewest and takeover of Virgin Mobile. He was described in the UK’s Daily Telegraph as “a top Goldman Sachs deal-maker”. A passive investment strategy would not have tempted him away, one feels.

There is, however, an interesting legacy from those deliberations about active versus passive. In order to justify its existence, CPPIB’s ‘actual’ active strategy in infrastructure is measured against a ‘virtual’ passive strategy. Carrier reveals that a team within the organisation manages a “reference” portfolio – known as the CPP Reference Portfolio – which shows how CPPIB’s infrastructure assets would perform if they were passively managed.

Suffice to say, it’s a benchmark that needs to be outperformed – and has indeed been outperformed to date, Carrier is quick to point out. In fiscal year 2012, CPPIB’s infrastructure portfolio posted a return of 12.8 percent, compared with 13.3 percent for fiscal year 2011. The entire portfolio’s return for 2012 – covering areas such as equities, bonds and real estate as well as infrastructure – was 6.6 percent.

While the merits of various strategies needed to be weighed, there is one thing that CPPIB never had doubts about – and that was the desirability of investing in infrastructure one way or another. “We have long-term assets and liabilities and infrastructure is very well tailored to that,” Carrier points out. “Because of our long-term focus, we can invest beyond the limitations of fund cycles. We look to hold our investments for 20 or 30 years.”

A ‘no’ to funds

This helps to explain why, despite having invested in private equity funds (as well as directly in private equity), CPPIB has never done likewise in infrastructure. “We don’t invest in infrastructure
funds, we only invest directly,” Carrier clarifies. He does add, however: “We might have a different strategy in emerging markets where direct investment may not be available or may not be the preferred option due to our lack of experience in a given market. So there is flexibility in the strategy in an emerging markets context, but our primary focus is on establishing preferred relationships with trusted local partners.”

The fact that CPPIB is looking for long hold periods means it is ready and willing to invest large tickets in individual deals – typically between $500 million and $2 billion per transaction.

For example, the firm invested over $3 billion in the take-private of Australian toll road operator Intoll in November 2010, around $2 billion in the take-private of Macquarie Communications and Infrastructure Group (MCG) in June 2009 and more than $1 billion in the purchase of a 49.99 percent stake in Chilean toll road operator Grupo Costanera from Italian developer Atlantia Group in April this year.

The firm’s enthusiasm for infrastructure means its infrastructure assets under management have grown fairly quickly to around $9.5 billion in fiscal 2012, accounting for 5.8 percent of the overall portfolio (real estate, the other part of the real assets category, accounts for 10.6 percent).

However, the firm does not intend to implement a formal allocation. “We don’t think in terms of allocations, we don’t believe in it,” says Carrier. “It forces to you sell and pushes you to buy at the
wrong time. But as the overall fund grows quite rapidly, we would like to increase our exposure to infrastructure in the context of this growing pool of capital.”

But how is CPPIB looking to grow that pool exactly? In terms of target sectors, the firm runs the rule over many of the usual suspects. Carrier names toll roads, utilities, airports, broadcast towers, bridges, ports and water companies as the kind of core infrastructure in which the organisation has an interest.

I point out that, in a recent interview with Infrastructure Investor, former Allianz Capital Partners chief executive Thomas Putter had said: “To me, an airport is not an infrastructure asset. The skills to make
an airport successful are operational skills – retail, marketing, resource allocation, operational efficiency and cost management.”

As a result of which, he saw airports as more of a private equity-type investment.

To which, Carrier responds: “We consider that airports have a catchment area and they’re regulated and so they fit our strategy. They are highly GDP-correlated so that can be considered a different risk profile.

But they have monopolistic features and a strong asset base. We would generally assign a higher discount rate to most airports and, as such, they can be considered different from most regulated utilities, but they’re no less infrastructure than the other areas we look at.”

More complex, the better “We consider ourselves reasonably conservative [in terms of sectoral approach], but we do complex deals,” Carrier claims.

“We’ve done two take-privates (Intoll and MCG) and they’re very complex. They’re difficult to do but we like them because we have control over our destiny. We seek negotiated outcomes such as we had with Atlantia in Chile [where CPPIB was recommended as a partner by Atlantia’s adviser Goldman Sachs] rather than competing in auctions and we believe that our unique characteristics and ability to transact in size position us well for these opportunities.”

One sector that CPPIB is not attracted to presently is renewable energy. Asked why, Carrier says: “We decided against renewable energy as it’s dependent on government subsidies, has technical risk and, as such, is not in line with our strategy.

The government angle has exacerbated risk over the last few years. And, in the US, the emergence of shale gas has put pressure on renewable energy.”

This prompts a further question about whether CPPIB might have a role to play in the US’ unfolding shale boom. “We would be interested in shale at some level of the ecosystem,” says Carrier. “For example, on the pipeline side it’s interesting to infrastructure investors. The economics of shale are still volatile but we are interested in gas, as evidenced by our investment in Gassled, and we believe in it strategically.”

CPPIB was part of a three-strong investment group, also including Allianz Capital Partners and the Abu Dhabi Investment Authority (ADIA), which acquired a 24.1 percent stake in Gassled – a Norwegian gas transportation business – in a $3.2 billion deal in June last year. The Canadian pension had a 45 percent stake in acquisition vehicle Solveig Gas Norway, while Allianz Capital Partners had 30 percent and ADIA subsidiary Infinity Investments 25 percent.

Carrier says it [Gassled] was a very attractive if “slightly unusual” asset. Why unusual? “It is not regulated and is an unincorporated joint venture that operates within a broader network. One needs a
macro view of gas within the context of the European energy market. It’s not a standard utility.” Perhaps because of this, many infrastructure funds chose not to pursue the opportunity and it was a “limited” auction, says Carrier.

As an aside, CPPIB was also part of one of the bidding groups for Open Grid Europe, Germany’s largest gas transmission network, which was sold to a consortium led by Macquarie Infrastructure and Real Assets for €3.2 billion in May this year – further evidence of CPPIB’s attraction to large gas deals, even if it was ultimately outbid.

London = capital of infrastructure

Carrier has an investment team of around 30 under him, divided between London and Toronto. At the outset, he says, the team numbered two or three. As he appears to cast a gaze outside the window as the wind blows and rain flecks the windows (in late Spring), I ask him why he’s based in London. Reading my mind, he quips: “It’s cold in Canada as well.”

He continues, in a more serious vain:

“I left Goldman Sachs to help set up the London office. That was my mandate, and I am also managing director of the London office as well as head of infrastructure.

But when I was asked to take over infrastructure two years ago, it made a lot of sense to be here as London is the capital of the infrastructure world.

It has the ecosystem in terms of advisers and large investors, it sits between the Americas and Asia so it’s in a good time zone, and it’s also one of the most developed markets in terms of the regulatory

But while the UK is seen as a desirable infrastructure market, we should not expect to see CPPIB piling money into the country’s much-hyped infrastructure renaissance plan – one that has gained added momentum in light of the UK’s struggle to emerge from recession. After all, much of this grand vision relates to greenfield projects. “What we do is mostly brownfield rather than greenfield,” Carrier points out. “The government wants capital for greenfield, which has an element of risk that’s different. You need to structure the investments so that long-term investors don’t take undue risk. But if they can find
a way of recycling capital from brownfield to greenfield, then that would be a good thing to do.”

Another developed market which is very much on the CPPIB radar is Australia.

In a speech to the Australian-Canadian Chamber of Commerce in Sydney earlier this year, CPPIB chief executive officer David Denison said the Australian market was “highly attractive” and that the pension
would like to grow its presence there.

Carrier points out that CPPIB already has exposure to the likes of Broadcast Australia, the country’s biggest broadcast transmission provider, and Sydney’s Westlink M7 toll road. Describing Australia as a
core market, he adds: “Australia is a close second to the UK in terms of providing a model for infrastructure investment with sophisticated regulation. However, recent tax changes have unsettled many investors.”

I ask whether being such an important institution in Canada means that CPPIB views its home market any differently than other markets – does it have any special responsibility there? “Canada is viewed the same as everywhere else,” insists Carrier. “We are divorced from political considerations. The board is
comprised of business people and our investment criteria are limited to investments that deliver the best risk-adjusted returns. There are good opportunities in Canada, for example we invested in the 407 ETR highway [in Ontario], but generally infrastructure assets in Canada do not have the scale necessary to fit our strategy.”

Emerging markets

Unsurprisingly, CPPIB is actively exploring opportunities in emerging markets.

And that means, also unsurprisingly, a thorough assessment of all the inherent risks. “What we look for in infrastructure is stability – not just political but regulatory,” says Carrier. “To a lesser degree, we are influenced by the stability or otherwise of interest rates and currencies as well. We look at how welcoming emerging markets are to foreign private capital and we find that some are closer to ‘investment ready’ than others.”

One of the ‘investment ready’ destinations, in CPPIB’s view, is Chile. The firm’s recent investment in Grupo Costanera, referred to earlier, is but the latest example of a number of deals CPPIB has done
there. It’s with reference to the firm’s 2006 investment in electricity transmission company Transelec Chile – as part of a Brookfield-led consortium – that Carrier says: “We had a good experience with very good, sophisticated regulation for foreign investors.”

Reflecting on the emerging markets approach as a whole, Carrier says: “It’s a measured approach, which we need to think very carefully about. Where we don’t have a physical presence, we have advisers such as [former Morgan Stanley and Credit Suisse investment banker] Vikram Gandhi in India. We are investing in countries we didn’t have the ability to invest in before – the extension of our strategy is around emerging markets.”

As CPPIB goes about expanding its reach into new markets, the need to recruit the right people is paramount.

This, Carrier insists, is no straightforward task. “It’s hard to attract people to the extent that it’s a relatively new asset class. There are not that many experienced professionals with a long history in this area.”

Hiring experienced staff is not the only challenge. Arguably the biggest challenge for everyone these days is the harsh reality of the macro-economic backdrop – even for those such as CPPIB that are confident growth can achieved. “Where there are economic challenges there is always risk and we see that in countries where there is belt tightening and budget deficits and the need to please electorates,” says Carrier.

In such a complicated world, the choice that CPPIB made in favour of active management looks like it may just have been a good call.