The hunt for growth

Q: In fiscal year 2014, Canada Pension Plan Investment Board (CPPIB) achieved a 16.6 percent return on infrastructure, which is slightly higher than the fund’s overall return of 16.5 percent. What are the major contributors toward this performance? How do you see returns for the asset class in the next few year?

AC: Infrastructure is one of CPPIB’s key asset classes and one that is very well-suited for our long-term investment mandate. The results from fiscal year 2014 were a result of the continued strong performance of our core transportation and utility investments.

That said, we are seeing a significant amount of competition for quality assets, and returns in the near future will likely remain tight on new investments. While we see a favourable outlook for our existing portfolio, the high level of competition means we are becoming even more selective on our investments to ensure we are targeting the right risk-adjusted return levels. This is particularly important as we take long-term views on assets and aim to achieve the best value over a significantly longer time horizon than most investors.

Q: What is the role of infrastructure in CPPIB’s investment portfolio? Infrastructure currently makes up over 6 percent of the total portfolio. Will this number continue to grow?

AC: Infrastructure is core to CPPIB’s investment programme. We are long-term, patient investors and infrastructure investments are very well suited to our investment mandate.

Our long-term horizon means that CPPIB is able to diversify into this unique asset class that suits the long-dated nature of the fund’s liabilities. Within infrastructure, attractive characteristics can include direct GDP linkages, inflation protections, predictability in returns from core drivers and regulation, and access to large investments in strategic markets.

The fund will continue to grow and our infrastructure programme will aim to keep pace. For that same reason, our strategy includes a focus on both larger investments as well as platform opportunities where we can re-invest capital in a long-term venture. We are dedicating resources that will allow us to pursue the right opportunities and we already have a team in place today to execute on our programme going forward.

Q: What is your view on the current global investment climate (including emerging markets vs. mature markets)?

AC: At CPPIB, we have a diversified investment portfolio, both in terms of asset class and geography.

We have identified a number of growth markets that appeal to us because of more dynamic macro environments and long-term growth outlooks, which would include markets such as India and Brazil, as well as other growing economies around the world. We believe that these markets fit well with our strategy of seeking investments in markets that, in our perspective, deliver attractive long-term risk-adjusted investment returns.

In addition, we believe the growth markets we’ve identified as priorities provide good opportunities for long-term investors like CPPIB because of the large existing deficit in, and growing need for, infrastructure and real estate development.

Alongside our investments in growth markets, we will also continue to seek opportunities in mature markets that fit with our investment mandate and those that we believe provide good value for us as a long-term investor.

Q: Is over-valuation of deals becoming a problem in European markets? How do you see investment opportunities in the UK? Do any other particular European countries interest you?

AC: Over-valuation has been a discussion theme for a couple of years. Low interest rates have driven many investors towards assets classes that are perceived to be relatively safe while still providing attractive returns. This trend, and the availability of cheap financing, has resulted in a significant compression in yield for most infrastructure assets.

But infrastructure assets are not risk-free, and it is easy to overlook regulatory or commercial risk associated with some assets in such a competitive environment.

As the cost of financing increases, as it will, some assets will inevitably see their equity returns compressed. Given the current regulatory and fiscal environment, it is very likely that the higher cost of debt will not be fully offset by higher free cash flow from the operating companies.

CPPIB is a unique investor because of our extremely long-term horizon which allows us to be patient when looking at new opportunities.

The UK market is currently showing a number of opportunities. As disciplined, long-term investors, we evaluate all potential transactions carefully to determine their fit within our strategy and mandate, and to evaluate their impact on the risk-return characteristics of the portfolio. The continued focus and joint effort of government and the private sector in the UK to drive infrastructure investment is also attractive to us.

In terms of other markets that interest us, we look at opportunities across most of Europe, with our active focus at the moment being mostly in core European markets like the UK, France and Germany. We also are exploring potential opportunities in Southern Europe. Eastern Europe is more opportunistic for us at present, although we believe that Turkey may be an attractive infrastructure market in the future.

Q: Direct investment, co-investment, separate accounts, pooled funds (listed and unlisted) or others – what is your preference?

AC: Of these, our preference is direct investments. With direct investments, we are able to capture key benefits including added governance influence and the ability to unlock further value through driving strategic initiatives. We are also able to provide guidance on the direction of the company, which as a long-term investor is important to our ability to get the most out of our investments.

We have built a team of experienced professionals that allows us to execute this mandate. It is very important to have the right people in place to support a programme like this. In addition, we have had good experiences with partners globally, and this should contribute to the long-term success of our platform.

Q: CPPIB is making moves in emerging markets, especially in Brazil and India, whereas many institutional investors remain cautious. What is the rationale?

AC: As an organisation, CPPIB looks for investments in growth markets that we believe will deliver attractive, long-term risk-adjusted investment returns, and both India and Brazil meet these criteria.

In addition, the development needs of markets like India and Brazil make them an attractive match for CPPIB’s long-term investment horizon. Both markets have strong fundamentals such as a growing middle class and rapid urbanisation that bring with them a need for increased investment in infrastructure and real estate, among others.

The governments in India and Brazil have also demonstrated a desire to incorporate foreign direct investment into their growth programmes, which is an important signal for investors like CPPIB. Since we look at a market's long-term prospects and take an equally long-term view, we are able to look beyond short-term disruptions. Such short-term volatility can often yield attractive opportunities.

Q: Do you think infrastructure debt investment is a rising trend?

AC: Many funds are setting up infrastructure debt units to participate in this sub-class. With traditional bank lenders retreating somewhat from large, long-dated loan commitments, the pool of lenders needs to widen. This creates opportunities for other sources of capital.

In many mature markets, there were already a number of new institutional lenders participating in infrastructure debt. As appreciation for the asset class has grown on the equity side, there has inevitably been more awareness across the spectrum, and large groups are now setting up specific mandates for infrastructure debt.

Q: Are there any specific sectors and destinations that will interest you in the next 12 months?

AC: Over the next 12 months, we believe it will be important to continue to keep a focus on key growth markets (which include not only India and Brazil but also other markets in Eastern Europe, Latin America and Asia), given the rapid changes we’re seeing in those markets. We will also continue to look at our core markets, including Western Europe, the UK and Australia.

Sector-wise, it will be dependent on the constantly moving macro landscape globally. We certainly will be evaluating the merits of regulated and GDP-linked assets in various markets, as well as sub-classes within those broader groupings.

Alain Carrier is a managing director, head of Europe and former global head of infrastructure at the CPP Investment Board.