CalSTRs moves to diversify
into roads, bridges, power lines

SACRAMENTO, Calif. — CalSTRS has made the first move in implementing a new infrastructure portfolio that could top $1 billion and help the pension fund reap excess returns while hedging against inflation.

The $169.2 billion California State Teachers’ Retirement System, Sacramento, is tiptoeing into infrastructure — potentially investing in power lines, bridges, ports and other assets — after mulling over the asset class for more than a year.

At the June 4 investment committee meeting, members approved the first draft of the policy for a fixed asset financing portfolio, or infrastructure portfolio, that will begin at $1 billion, but will grow if the initial investments prove successful, according to an agenda item from the meeting.

CalSTRS, like other investors who have recently carved a slot for infrastructure in their portfolios, sees the asset class as a hedge for long-term liabilities, a hedge against inflation and an avenue of diversification for the overall investment portfolio.

Also prompting interest is the expected low returns of the equity markets in coming years, said Alan Biller, president and founder of consulting firm Alan D. Biller & Associates Inc., Menlo Park, Calif.

Only one of the firm’s 65 clients now invests in infrastructure, but three more plan to make maiden allocations in the next six to nine months, he said. Mr. Biller declined to name his clients.

Taking liquidity risk to beat inflation

Infrastructure investors are willing to take on the liquidity risks in this relatively nascent — at least in the U.S. — asset class. With the U.S.’s developed municipal bond market, the need for investors to invest in infrastructure hasn’t historically been as pressing as in other countries.

Christopher Ailman, CalSTRS’ chief executive officer, has been discussing infrastructure investments with the board since 2006 and the investment committee held an educational session in 2007 on the asset class. “We’ve laid the groundwork to building and understanding the issues,” said Sherry Reser, spokeswoman at the pension fund. Mr. Ailman was not available for comment.

If approved, funding will come from the $31 billion fixed-income portfolio. The investment committee will likely vote on a second draft of the policy at the July 10-11 meeting, with an implementation plan scheduled to be presented at the Sept. 3-5 meeting.

Staff at CalSTRS expect a real return, net of fees, of at least 5% and will target returns, also net of fees, of CPI plus 1.5%. They will also likely target separately managed accounts and look at private-to-private deals.

Private-to-private deals, where private owners sell to investors, comprise most of the infrastructure deal flow, according to the CalSTRS agenda.

“You want private deals,” said Mr. Biller. Public deals, where a government entity, for example, shops its wares in a public auction, can attract too many bidders and drive up the price of the asset, he said.

The winner often “suffers winners remorse” in public deals, said Mr. Biller.

Separately, to limit risk, CalSTRS staff has laid down some preliminary guidelines about the style of investment — core, value added or investments in global, publicly traded infrastructure companies.

CalSTRs can include international, emerging markets

Staff expects a range of 30% to 70% in core investments, 30% to 50% in value added and up to 30% in public equities. Publicly traded infrastructure companies are more volatile than their private counterparts, but add liquidity to the portfolio, according to the policy.

Up to a third of the portfolio will be in non-U.S. investments and up to 10% of the total portfolio can be in emerging markets. The remaining assets will be in the U.S., with an emphasis on California.Infrastructure investing in the U.S. is still an emerging industry compared with the Australian, Canadian or European markets. In fact, some pension fund executives, like David Pontius, manager of pension investments at the $1 billion Shelby County Retirement System, Memphis, Tenn., view the young age of the asset class in the U.S. as a big opportunity.

Still, before Shelby County approved an initial allocation of 0.5% in October 2007, there was a concern about the illiquid nature of the asset class, he said.

But a major driver behind the initial investment was a belief the U.S. government would be unable to meet the country’s infrastructure needs without the investments from the private sector, said Mr. Pontius. The American Society of Civil Engineers estimates that $1.5 trillion is needed to bring infrastructure in the U.S. to good condition.

On June 3 the board doubled its allocation to infrastructure to 1% of the portfolio, or $10 million. “We like infrastructure because it offers fixed-income-like volatility, but with better returns,” he said.

Larger pension funds are also investing. Last December, the $245.4 billion California Public Employees Retirement System, Sacramento, earmarked a 1.5% allocation for infrastructure as part of a larger, 5% carve-out to inflation-linked assets. As of May 12, CalPERS had not invested in infrastructure because officials are still in the process of approving an investment policy, according to documents on the pension fund’s website.

Contact Raquel Pichardo at rpichardo@pionline.com