'Unleash private investment in every way possible'

Infrastructure Investor: New York gathered many bellwether participants in the infrastructure asset class for a passionate debate about the opportunities and challenges facing them. Cezary Podkul introduces the top 10 takeaways from the event.

On September 29 and 30, we hosted some of North America’s most influential figures in the infrastructure investment business . In case you were unable to join us, here are the 10 key themes that were  discussed at the event.

1) Northern self-reliance. In North America, both US and Canadian pensions have shown an appetite for infrastructure. But they have approached the asset class in different ways, and will most likely continue to do so. A number of Canadian pensions have developed the in-house expertise to invest directly, while US pensions have continued to invest indirectly through funds. A stark illustration of why these trends are likely to prevail at least in the short term: Mark Wiseman, vice president of private investments at the Canada Pension Plan Investment Board, had 30 full-time investment professionals staffed on CPPIB’s buyout of the Macquarie Communications Infrastructure Group this summer. Most pension plans can of course only dream of such resources. Speaking over lunch, a lonely US pension representative commented: “You’re looking at our direct investment team”.

2) The honeymoon is over. A new risk is popping up that infrastructure managers must be mindful of: credibility. For years, infrastructure has been marketed as a lower-volatility, lower-return asset class. But for some investors who adopted infrastructure early on, performance has not lived up to those promises. They are now rightfully retrenching and re-thinking the role of infrastructure in their portfolios. The industry will have to do its part to deliver the strategy that was promised. One reason why: “Infrastructure assets are not stable. They go through cycles,” Matina Papathanasiou, partner at QIC Infrastructure, told the audience. Going forward, managers need to make promises they can keep or just not make them.

3) Green movement. Pension appetites in the US are still thought to overwhelmingly favour brownfields, or existing assets, as opposed to greenfields, or assets that have yet to be built. But that could be changing. Our poll of the conference audience found that 86 percent of delegates thought pensions want to invest in brownfields. Asked why, though, one manager quipped: “they’ve been misled” – just one indication that the market sees opportunity for pensions to invest in more greenfields in the future. The textbook example so far, cited more than once at the conference, is the Dallas Police and Fire Pension’s investment in the $2.7 billion “New LBJ” expressway project in Texas, a greenfield. Several developers and investors at the event thought we may see more investments like this in the future. So while brownfields may still be the dominant preference among pensions, don’t be surprised if their portfolios add a tinge of green in the future.

4) Hybrid investments. Market practitioners still see the US market trending more toward greenfields in transportation infrastructure. But it’s not a bipolar world: panelists on a “greenfield vs. brownfield” panel said assets that blend characteristics of both asset types are likely to dominate infrastructure investment in the coming years. These “hybrid” investments could include brownfields with very high capital expenditure requirements or half-completed projects that require the private investor to finish a road and award a concession for the portion that’s already built. A corollary to this trend might be the extinction of the terms “brownfield” and “greenfield”: several conference attendees objected to their tendency to over-simplify reality.

5) Risk control is hot. Reality can also bite managers, as evidenced by the worst recession since the Great Depression and the volatility it has caused in management models for toll roads, airports and ports. Where there is GDP-linked demand risk tied to the assets, many of the value drivers are beyond the asset managers’ control. One cannot force people to fly airplanes or drive cars. So a view is emerging that it’s better to focus on strong risk management since prudent asset management – a big talking point on the conference circuit in recent months – can only take you so far. Among the people making this point most forcefully at the conference was Melbourne-based Macquarie Funds Group managing director Peter Johnston, who urged investors to “look for managers who mitigate risk”.

6) Under-utilised utilities. Others are asking: if you’re investing in infrastructure, why take on demand risk at all? In the US, though toll roads and parking meter assets have received much attention from the media and investors, another asset class – utilities – can often offer less demand risk, steadier returns and the possibility to negotiate with a private, as opposed to a public, seller. Several non-US investors were scratching their heads wondering why so many managers are eager to enter competitive bidding situations for public assets instead of focusing more on negotiating proprietary transactions in the US utility sector.

7) Availability skepticism. If you want to avoid demand risk but stay in the transportation sector, transaction structures featuring availability payments are the way to go. But while there is much optimism about this payment structure’s future in the US, that optimism is tempered by the stark reality that governments that offer these payments to private investors in exchange for service provision must get the money from somewhere. Already cash-strapped states are reluctant to issue debt to finance availability payments. Shirley Ybarra, now a senior transportation analyst at the Reason Foundation, said she tried and failed to do an availability payment deal in Virginia in the late 1990s because the state did not want to indebt itself. Unless states find new transportation revenue sources or seek out deals with ready sources of revenue, availability payment deals in the US are likely to face similar opposition.

8) Why there’s more equity in India. In terms of geographic focus, there is much excitement about China and India as potential markets for infrastructure. But our panel of emerging-market investors cautioned the audience that there is a world of difference between the risks associated with these two markets. China has not adopted the same protections for investors as India and many of the potential investments in the water utility and toll road sector face uncertainty from government rate-setting. India, on the other hand, is adopting standard concession agreements that more clearly delineate risks and rewards for investors. Consequently, much of China’s infrastructure build-out is being financed with debt, while India has been able to attract more equity. But not enough: “What a country like India needs is big ticket equity, $100 million-plus, which is conspicuous by its absence,” said Srivasta Krishna, an officer in the Indian Administrative Service, India's top management government cadre.

9) Keeping the three Ps on the table. The US, of course, is also an emerging market – for infrastructure, that is – and one panelist wryly suggested that foreign investors should demand an emerging market premium for investing there. Public-private partnerships (PPPs) remain difficult to execute but the question of their prevalence in the future may be more a matter of necessity than convenience. Pennsylvania governor Ed Rendell said there’s no more money in US states’ transportation budgets for projects such as Boston’s $15 billion “Big Dig”  underground highway tunnel: “There will be no more Big Digs in America,” Rendell said, adding that he wants politicians opposed to PPPs to “show me the money and I’ll take the three Ps off the table”. With states facing a collective $230 billion in budget deficits between 2009-2011, the three Ps are likely to stay on the table.

10) LilliBAButians. But PPPs won’t work in all cases. Thanks to Build America Bonds (BABs) – taxable municipal securities that offer issuers a 35 percent subsidy on their interest costs – US governments are able to issue debt more cheaply than ever to fund infrastructure projects. Bankers gathered at the conference acknowledged that these bonds will continue to remain a formidable force in infrastructure financing in the US. So, as any investment banker with a dual PPP advisory and BAB underwriting capability will tell you, it’s better for investors to focus on recognizing where municipal financing makes sense and where PPPs are a better deal than to unilaterally push for PPPs as the answer to everything. The municipal financing market, which one panelist compared to the Lilliputians holding down the giant of private investment in the US, is not going anywhere.

Setting these trends aside, one overriding sentiment was clear: Over the long-term, investors remain optimistic. Compare and contrast Governor Rendell’s remark that “we’ve got to unleash the power of private investment in every way possible” with what KKR energy and infrastructure head Marc Lipschultz told delegates: “I think we are facing an opportunity set that is large, long and attractive”. Combine these two messages and it is very clear indeed that leading lights on both the public and the private sector side are starting to see eye-to-eye.