Infrastructure not just for pensions anymore

Infrastructure investing was a fast growing asset class well before the financial crisis. Billions of dollars in government stimulus money has now been earmarked to this asset class, adding even more depth and opportunity. If used properly, infrastructure can create a nice sustainable income yield.

For the most part, infrastructure projects have long been the purview of institutional investors who can partner with contracting and construction companies to finance infrastructure projects.

There are a growing number of investment pool offerings that offer investors direct exposure into infrastructure assets. The latest is Connor, Clark & Lunn’s (CC&L) GVest Traditional Infrastructure LP, which offers both institutional and retail clients the opportunity to invest in newly formed partnership between CC&L and The Graham Group, one of Canada’s largest construction companies.

As an equity provider, CC&L is essentially supplanting a role provided by private equity or pension partners, and providing direct capital into infrastructure deals.

Many of the deals are expected to be public/private partnerships (P3) arrangements that Graham [who/what is Graham] consistently bids on, according to Matt O’Brien, president of CC&L. These deals see the government backstopping private development of traditional infrastructure projects.

“For the last three or four decades there has been significant underinvestment in basic infrastructure, in both Canada and in the U.S. Its been outpaced by the growth of GDP for a significant amount of time,” O’Brien says. “In the near term, the catalyst for spending is economic stimulus. Governments have taken the lead in investing directly in infrastructure. In the medium term, the driver for spending will be the need to continue to renew our basic infrastructure.”

He adds, “A significant component of the several hundred billion needed in Canada, and the couple trillion in the U.S., will need to come from the private sector.”

How P3 investing works

In the case of CC&L’s partnership, Graham will be actively bidding on projects. They are obliged under the terms of the deal to bring any equity investment opportunities to CC&L.

“Over the last three years, Graham has been involved with more than $3 billion in infrastructure construction. It’s a partnership between us, where they bring access to deal flow; they bring construction expertise. They bring expertise in developing niche products and bidding into the P3 process. We bring investment execution expertise, debt origination and structuring expertise. We bring access to capital and we bring fund administration expertise,” O’Brien says.. “All of the economics are arranged at the outset and it’s basically on a 50/50 basis.”

O’Brien says most of the P3 projects built in Canada are availability projects, which means the private sector designs and operates the project for the government and in return, the government enters a long-term contract that pays the private partner a stream of cash flow over the life of that concession. Usually those agreements range from 15 to 40 years.

CC&L’s partnership will focus on traditional infrastructure products.

“That broadly covers two asset types, civil infrastructure assets, which are roads bridges and ports and public transit. Most of it is transportation related,” O’Brien says. “The second category is social infrastructure, which is schools, hospitals, justice facilities, police and fire stations — any asset with a social connection.”

Once completed, these projects can provide a fairly sustainable yield, which CC&L is currently targeting at about 12% to 17% per annum, but that return is far from guaranteed. The project has to be financed and completed in order to see that return.

Realizing returns take time

Unlike other investment funds, investors need to be patient with infrastructure funds. Pension funds with long-term time horizons have no problems with this. Retail investors may have to wait for three to five years until they start seeing a return on the money.

“We would expect projects will have a two- to three-year construction horizon and we will expect the value of the underlying asset to appreciate as we me move through construction and reduce construction risk,” O’Brien says.

Construction risk is reduced by negotiating contracts with fixed terms, he says.

“Most of the investments we will make will be construction stage investments of projects. The risk you’re exposed to is construction risk. On any of the projects, we, the equity investor will enter into certain construction contracts with a builder,” he says. “[Our financing agreement] will commit them to deliver the project on budget and on time and assume the risk of cost overruns. As a result, this partnership, as the equity investor in this project, will insulate us against those core construction risks.”

CC&L will also negotiate similar fixed financing agreements for the maintenance of projects. There is a big risk variable related to the credit quality of third parties that investors place their money with. If they run into financing problems, it can deep-six the project. For this reason, P3 projects are desirable because the credit quality of government financing is impeccable.

“One of our objectives at the outset of these projects is trying to raise debt financing, whose duration or terms match the terms of the underlying concessions so we’re insulated against refinancing risk,” O’Brien says. “There is never any guarantee you’ll be successful in doing that in every project but that’s the objective.”

(For BenCAn)

P3 unique opportunity for smaller plans

P3 projects have never been an area that smaller pension plans or high net-worth investors have been able to access. Large pension funds can offset their long-term liabilities by funding these projects, receiving the predictable cash flow that can last decades.

As managed investment pools enter the equity financing aspect of infrastructure, it will allow smaller plans to create similar cash flows without having to deploy the massive amount of upfront capital needed to finance a P3 project.

“We would expect after three or four years that we [will] have a pool of investments that will be generating a cash-flow stream that will then be distributed out to investors and the investment vehicle,” O’Brien says. “There is obviously a subset of the pension fund world, such as CPP, OMERS, the Ontario Teachers Pension Plan, that can invest directly in these types of projects. There is a whole universe of pension plans that are smaller than the top 10 that aren’t able to access this area directly and need to do it through some sort of fund structure or investment vehicle.”

(04/21/09)