The infrastructure asset class, while gaining an allocation in many institutional portfolios, is still in its early days and is evolving as an investment, according to a recent column in Infrastructure Investor (“Seeking an identity,” September 2013). In particular, the article says, “many in the asset class have questioned the applicability of the ten-year fund structure, which is a reminder of infrastructure’s roots in private equity”.
As an asset manager focusing on energy infrastructure, I heartily agree that the options for infrastructure investment are changing. Investors and managers are seeing evolution in funding mechanisms and structures. Over the past two decades new ideas have emerged – and will continue to come along – seeking greater efficiency in capital deployment, as well as suitability for the varied needs of the world’s investors.
The capital markets often respond to investors’ needs with innovation – and we all benefit from the availability of alternative structures.
An example is the emergence of master limited partnerships (MLPs), which have helped finance the build-out of energy infrastructure. Until the 1980s, funding this infrastructure meant buying into private equity rounds – illiquid, undiversified and sometimes almost non-existent. MLPs added liquidity through publicly traded partnerships and diversification via broader portfolios of assets. Today, more than 90 US energy MLPs have a total equity value of about $422 billion.
Liquidity and diversification
Another innovation came a decade ago. Tortoise Capital Advisors, which I was privileged to co-found, began creating closed-end funds to invest in MLPs, offering still more liquidity and diversification. Tortoise now has $13 billion in AUM, and about 40 closed-end and open-end funds today manage portfolios of energy MLPs.
Still, some infrastructure investors avoid MLPs and funds that invest in them – largely over the “tax suitability” issue. US tax treatment for partnership interests is much more complicated than for common stocks. Instead of simply reporting dividend income based on a Form 1099, for example, each MLP investor gets K-1 statements and reports a proportionate share of the MLPs’ income, gains, deductions and losses.
Tax-exempt investors such as endowments, pension funds, 401(k)s and Individual Retirement Accounts are restricted in MLP ownership due to the characterisation of “unrelated business taxable income”. Yes, taxable – even in tax-exempt accounts. Non-US institutions also generally avoid owning MLPs to avoid “effectively connected income”. Additionally, mutual funds have limitations on ownership of other 1940 Act funds that invest in MLPs.
Once again, market need is spawning capital structure innovation. Our team at Tortoise decided two years ago to develop a new listed vehicle for investing in energy infrastructure. We began with the fact that many logistical assets – such as pipelines for moving oil, natural gas or water, or transmission lines for moving electricity – sit on or under corridors of real estate.
Following IRS rules and precedents, we developed a Real Estate Investment Trust (REIT) structure to invest in these corridors of energy infrastructure. The result is CorEnergy Infrastructure Trust, Inc., a New York Stock Exchange (NYSE)-listed company that formerly was part of the Tortoise fund family. Since 2011, CorEnergy has divested MLPs and most other financial assets and invested in REIT-qualified infrastructure. Well over 75 percent of CorEnergy’s assets are now real estate, and we expect to qualify for tax-advantaged treatment as a REIT at year-end.
As we engage investors, we find they are intrigued by the REIT structure. It offers the yield characteristics of energy infrastructure (5 to 7 percent), a risk profile based on stable fixed-fee leases and mortgages, and growth prospects amid the energy boom – plus a simple tax structure involving ordinary income shown on a Form 1099. Finally, a REIT is not a 1940 Act fund, enabling broader ownership by global fund managers.
We expect the advantages of this emerging approach to produce substantial growth in capital invested in energy infrastructure through REITs. After all, real estate is as integral as private equity to what your magazine calls the “identity” of infrastructure.
President and chief executive officer
CorEnergy Infrastructure Trust Inc.