On the rails
The emergence of infrastructure as an asset class has largely been driven by macroeconomic factors, explaining to some extent the varying stages of maturity in different countries. Traditionally governments have facilitated investment in infrastructure either by directly financing and building roads, railways, electricity grids and telephone lines, or by subsidising others to do so. Increasingly, however, political pressures to reduce taxes and balance budgets, combined with the escalating cost of continued improvement in the provision of infrastructure, have caused governments to look for alternative funding methods.
As a result, infrastructure investment in the developed world has been gradually moving from the public to the private sector. Related to this has been the growing acceptance of a ‘user pays’ approach, with the role of government changing to that of regulator rather than provider of services. This has opened up ownership and provision of infrastructure services to the private sector, providing a stream of investment opportunities and giving rise to the development of an increasingly sophisticated infrastructure investment market.
The intrinsically low-risk nature of infrastructure assets stems from their importance to the community. Infrastructure assets – roads, water utilities, railways, airports, ports, electricity and gas transmission and distribution networks – are the basic services and facilities on which the growth and development of a community depends. In addition, barriers to entry, such as high development and construction costs and environmental long-term contracts, provide infrastructure assets with a sustainable competitive advantage. The essential and long-term nature of infrastructure assets leads to stable and predictable consumer demand, resulting in cashflows that can be more reliably predicted than those generated by other asset types. From an investment perspective, this stability of operating cash flows serves to reduce overall volatility of returns.
In Europe, private investment in infrastructure is growing, a trend that is likely to continue for the foreseeable future. The total value of European infrastructure transactions completed since 2000 is approximately e140bn, with around e95bn closed in 2002. Examples include Warnow Tunnel, Germany’s first toll road, due to open in late 2003; the M6 Toll, Britain’s first privately developed toll road; the Irish Public Private Partnership programme, and the privatisation of the French toll road Autoroutes du Sud de la France (ASF). As European pension funds look towards alternative investment assets to diversify portfolio risk and provide absolute returns, many are starting to consider infrastructure opportunities where the demand for capital is strong and growing.
At the other end of the spectrum is Australia, where infrastructure forms part of the core investment focus of many pension funds, life companies and other holders of long-term liabilities. In the early 1990s, the Australian government gave a major boost to retirement savings by introducing a compulsory contributions scheme. The subsequent growth in pension fund assets coincided with a significant push from government towards private sector funding of existing and new infrastructure. Pension funds were quick to grasp the opportunity to invest in a new asset class at the core of the country’s economic development.
Today, it’s not uncommon for Australian pension funds to allocate 5% of their portfolio to privately held infrastructure equity investments, in addition to further exposure through listed infrastructure investment stocks. Pension funds in Australia account for about 80% of equity interests in private airports and toll roads, and are approaching 50% of equity interests in gas and electricity networks.
Private market infrastructure equity has provided Australian pension funds with consistent outperformance over the listed equity market. Many funds have achieved a return premium of more than 4% above listed equities with annual volatility closer to that of bonds. Pension fund investors have also benefited from the low correlation to other asset classes, particularly in the recent environment of highly volatile global equity markets.
Privately owned and operated infrastructure is a vital component of the economy, providing essential services to millions of Australians and employing more than 1% of the workforce. A recent survey shows more than 200 individual privately-owned public infrastructure assets, with a total value of investment of about A$113 bn (e65bn).
Meanwhile, in Canada, major pension funds such as Ontario Teachers, OMERS, Caisse de Depot (CDP), Canada Pension Plan Investment Board (CPPIB) and BC Investment Management Corporation (BCIMC) have taken the lead as infrastructure investors over the past five years.
Canada’s watershed infrastructure transaction was the Ontario government’s 1999 privatisation of Highway 407 in suburban Toronto. The 99-year concession was awarded to a consortium that included SNC Lavalin, a Canadian engineering company, Spanish conglomerate Ferrovial and the Quebec pension plan CDP. Highway 407 inflation-indexed bonds were purchased by Ontario Teachers and both OMERS and BCIMC were members of unsuccessful bidding consortia. This was the first large-scale participation of pension funds in an active bidding environment.
However it wasn’t until 2001, when TransAlta, the investor-owned electrical utility in Alberta, sold its electrical transmission system to the Altalink consortium, that infrastructure really seized the imagination of Canadian pension fund investors. The Altalink consortium comprised SNC Lavalin, Ontario Teachers, specialist investment bank Macquarie and Transelect, a US-based independent transmission company. Altalink surprised most observers by beating every major utility player in the country. Subsequently, Macquarie’s equity interest in Altalink formed the seed asset for Canada’s first pooled infrastructure private equity fund. The Macquarie Essential Asset Partnership raised C$250m (e156m), predominantly from pension fund investors, in early 2003 and plans to raise further equity before the end of this year.
For pension funds, the long-term sustainable yield provided by infrastructure assets is particularly appealing. Assets generally come with operating concessions of at least 15 years – the average concession length in our group’s e9bn global portfolio is 27 years, with 80% of the underlying revenue linked directly to inflation. Infrastructure assets can therefore provide a match for a defined benefit plan’s liability profile while delivering a risk-adjusted return well in excess of the available alternatives. Considering the limited supply and shorter term of inflation-linked debt, infrastructure equity offers an attractive alternative while also offering long-term investors an ‘illiquidity premium’.
In more mature markets the data is now available to enable initial technical analysis of the sector, supporting the well-documented fundamental analysis. A recent study we undertook shows Australian unlisted infrastructure equity has produced exceptionally low volatility of returns, and has significantly outperformed other asset classes both in absolute terms (perhaps not surprising for a defensive asset in the current market) and on a risk-adjusted basis, as the graph illustrates. The same study shows a negative correlation between unlisted infrastructure equity and other major asset classes. This diversification aspect is clearly a further drawcard for pension funds.
Discussions with many European investors confirm that infrastructure as an asset class offers a range of characteristics that are appealing to institutions with a longer investment horizon. This fast-emerging asset class is poised for sustained growth and, as has been the case in other countries, it is the early adopters who will benefit most.
Arthur Rakowski is a division director and infrastructure specialist with the Macquarie Bank Group in London