Retail investors largely locked out of infrastructure

With Ontario toying with the notion of selling a 20% stake in government enterprises such as the Liquor Control Board of Ontario, the Ontario Lottery and Gaming Corporation and Hydro One, infrastructure investing is moving from the hidden fields of alpha to mainstream beta: an asset class everyone can invest in.

But the terms and conditions for infrastructure are not quite conducive to a retail audience. In some sense, infrastructure should be combined with real estate as a single asset class, suggests Carol Penhale, principal at investment consulting firm Cutter Associates Canada. Both are primarily yield investments, with a cash return that trumps whatever capital gains might be achieved.

To be sure, there are retail infrastructure funds, just as there are retail real estate funds. But both invest in companies that are already publicly traded. Certainly, those companies will have characteristics that will differentiate them from other publicly traded companies, since they are long-dated assets — capital gains take a back seat to regular earnings.

In Ontario’s proposal, the 20% stake in government corporations will be destined for major pension funds, such as the Ontario Teachers Pension Plan and the Ontario Municipal Employees Retirement System. Both are already key players in real estate as well as infrastructure.

But retail investors are not necessarily shut out of real estate and infrastructure. There are pooled funds that offer access — but much like private equity funds, they involve a long time horizon as the investments mature, suggests David Rogers, president of Caledon Capital Management, which specializes in private market investments for smaller pension plans, endowments and family offices. He was speaking at the IMN Canada Cup of Investment Management in June.

Still, such assets have low correlations to equity markets, and they can protect against inflation. Toll roads, power plants and waterworks price according to the cost of service, plus profit.

Better returns are derived from directly owning the asset, says Rheal Ranger, CFO at Borealis Infrastructure, a subsidiary of OMERS that now has $7 billion in infrastructure investments deployed across the globe. These are almost solely direct investments made with partners in such assets as Bruce Power, PEI’s Confederation Bridge and Toronto utility Enwave. “We think we can get a better return when we control the asset.”

That, of course, means building a management team — and OMERS now has 12 years experience in infrastructure markets, plus a team of 50 professionals.

That raises the question: who’s putting infrastructure on the market. Toll roads and airports and seaports are being sold around the world to pension plans with dedicated teams to optimize asset management.

In Ontario, such efforts are much more modest, and dedicated to restoration and rebuilding works that are dicey for many pension plans, fearful of bad publicity and protests from plan members who are unionized.

Still, Jim Cahill, vice-president of project finance at Infrastructure Ontario, reports that $7 billion in private-public partnerships have been let since 2006. But, these are not necessarily open to the investing public.

Rather, construction firms bid to build hospitals, court houses — even service centres/rest stops on Highway 401. Construction loans are financed by the banks. But there is longer-term debt floated for the concession period — the period during which a private sector company runs the franchise on a court house, highway service station or hospital.

That debt is underwritten and sold in public markets, often to pension and mutual funds. It yields between 285 and 325 basis points over equivalent Government of Canada bonds.

Direct investors in such “social P3” projects can expect to see an internal rate of return of 11% to 12.5%.

That’s along the lines of what OMERS targets, says Ranger.

That’s fine and good for pension plans with long horizons, suggests investment consultant Bob Bevan. But smaller pension plans, family offices and others in the infrastructure space may be counting on cashing out much sooner.

That suggests that pooled funds have a mismatch between an asset’s maturity and the liquidation horizon of the fund. Pooled funds generally have a 10-year lifetime.

But Rogers says that newer pooled funds are extending their life, and allowing investors to buy an interest in the underlying assets of the fund once the fund is terminated.

(06/30/10)