Infrastructure no longer an investing wallflower

Infrastructure is a strapping adolescent of an asset class that already has had its share of growing pains.

It's been a rough few years. During the recession, fundraising of infrastructure private equity funds plummeted 80%. Some infrastructure managers disappeared, while others suffered from low returns caused by taking on too much leverage.

But much has changed in the past 12 months. Stock market volatility is making infrastructure more attractive to investors searching for lower volatility investments with steady returns from big assets — such as airports — that often have little competition, industry insiders say.

Infrastructure fund managers worldwide now have a total of $65.2 billion in capital committed but not yet invested in their funds, according to London-based alternative investment research firm Preqin.

Investors are adding infrastructure allocations or beefing up existing ones. But they are not filling these allocations the old-fashioned way — strictly with funds. Instead, even smaller investors are crafting co-investment strategies and investing in separate accounts. Larger investors are keen on making direct investments, with an assist from a manager or a consultant to find prospective deals.

Among experienced infrastructure players investing directly in projects are the Abu Dhabi Investment Authority, China Investment Corp., Government Investment Corp. of Singapore, Ontario Teachers' Pension Plan, Canada Pension Plan, Ontario Municipal Employees Retirement System, California Public Employees' Retirement System and California State Teachers' Retirement System.

“The longer an institution has been an (infrastructure) investor, the more likely it will invest directly, as long as it is large enough, has the corporate governance, the compensation scheme and the ability to attract qualified, experienced personnel,” said Mark Weisdorf, CEO and head of OECD infrastructure investment at New York-based J.P. Morgan Asset Management.

“(For) some of the Canadian, Australian, Dutch and Spanish investors, those that do have the experience and expertise, it is a natural evolution of any investment strategy,” he said.

The $9.1 billion New Mexico Educational Retirement Board, Santa Fe, has an infrastructure allocation of 3.5%; the investments' net asset value is $89.82 million.

New Mexico Educational officials started investing in 2008, primarily in funds, but now also do co-investments. System officials recently hired a new infrastructure consultant, Toronto-based Caledon Capital Management Inc., whose team has direct investing experience. Board staff members intend to recommend creation of a co-investment platform.

But interest in infrastructure investing had slowed starting in 2008 because investors were dealing with the fallout of the financial crisis, Mr. Weisdorf said.

Now, within the past 12 months, several institutional investors have created new allocations or beefed up existing ones. They include the Oregon Investment Council, New Mexico Investment Council, Alaska Permanent Fund Corp. and CalPERS.

Another result of the financial crisis and recession was the changing roster of infrastructure managers. Some did not survive the recession, and new firms were formed by executives from fallen organizations starting anew.

Some of the biggest infrastructure managers stumbled badly. Babcock and Brown Ltd., Sydney, Australia, one of the largest infrastructure firms, disappeared completely as a result of taking on too much leverage. Brookfield Investment Management bought about 40% of its assets; the North American infrastructure business spun out, and is now SteelRiver Infrastructure Partners.

“One of the principal missteps was forgetting transportation assets need a higher nominal return to reflect their higher economic sensitivity,” Mr. Weisdorf said. “For those folks that put on too much leverage or paid too much for transportation assets, or both, (they) will have a hard time of it or are gone.”

During the financial crisis, the poor performance of the road sector of transportation investments astounded many investors and managers who did not anticipate that people would curtail their driving.

In 2009, Macquarie Infrastructure Group cut the value of its toll road assets by about 28%. In a statement to the Australian Stock Exchange at the time, executives blamed the economic crisis, lower traffic volumes and high financing costs. At the time, Macquarie Infrastructure's U.S.-based projects included the Chicago Skyway, Indiana Toll Road and the Dulles Greenway toll road.

“It is a fair observation, today, that the miles driven in the U.S. have declined through the period of the financial crisis more than anyone had experienced in the past,” Michael Cook, senior managing director, in the New York office of Macquarie Infrastructure and Real Assets, said in an interview.

This doesn't mean Macquarie has sworn off transportation projects. On Dec. 5, Macquarie announced it is leading a consortium to build the Midtown Tunnel Project for the Virginia Department of Transportation. It is a $2.1 billion project that includes new roads and a new tunnel, with the state retaining ownership of the assets, Mr. Cook said.

In all sectors, however, investment activity has picked up, he said.

“When I look at the deal pipeline, it is deeper and broader than it has been for some time,” Mr. Cook said.

The financial crisis slowdown also crushed midsize and smaller infrastructure managers.

“What has happened is the recession culled out midmarket and smaller market firms,” said Mark Canavan, senior portfolio manager for real assets at the New Mexico Educational Retirement Board. “Fifteen (percent) to 20% of the people I interviewed in 2008 and 2009 were never able to close a fund.”

But some larger managers survived, including Global Infrastructure Partners, J.P. Morgan, Citigroup, Credit Suisse and Alinda Capital Partners.

Not all private equity firms are continuing their infrastructure push. After two years trying to raise an infrastructure fund, Blackstone Group spun out its infrastructure group — now called Stonepeak Infrastructure Partners — over the summer.

Other managers that tried the asset class and moved on are returning, such as Kohlberg Kravis Roberts & Co LP. And executives from organizations that stumbled are forming new ventures. Tiger Infrastructure Partners is a new firm headed by Emil W. Henry Jr., who was global head of Lehman Brothers' infrastructure private equity business. Five of Tiger's six-member senior investment management team were former members of Lehman Brother's infrastructure unit.

And other firms are expanding. Deutsche Bank is ramping up its infrastructure efforts in the U.S., said Mayura Hooper, New York-based spokeswoman. While the bank has had an international effort for several years, last year it established RREEF Infrastructure Americas as a separate business. Although coordinated with the global business, the U.S. effort will be more focused on energy, Ms. Hooper said.

The types of investments have changed too. Today's infrastructure investors have little appetite for investing in projects from scratch — so-called “greenfield” investments — and many investors are staying away from infrastructure that require government subsidies, like solar power, that could be pulled back in the tough global economy. Instead, investors and the managers who invest on their behalf prefer “brownfield” projects — where investments are made in upgrading existing infrastructure that will provide consistent income, a moderate return and a possible hedge against inflation.

Among infrastructure investment, energy projects — including electricity transmission and distribution, and gas transmission and distribution — have been growing in popularity. Energy accounted for 36% of the $277.2 billion of worldwide infrastructure projects financed in the first nine months of this year, according to Dealogic, a London-based research firm.

One firm, First Reserve Corp. has raised about $1.5 billion to invest in energy infrastructure.

Energy is also on the minds of executives of the $14.4 billion New Mexico State Investment Council, Santa Fe. In July, the fund established a 10% allocation to real assets, which includes infrastructure as well as timber and energy, noted Charles Wollmann, spokesman. Like other investors, council officials look to infrastructure to provide stable returns and diversification for the entire portfolio.

“We don't want to live and die by the equity market,” Mr. Wollmann said.

One of the most active infrastructure investors, the C$152.3 billion (US $149.4 billion) Canada Pension Plan Investment Board, Toronto, has made energy an investment focus this year, according to its website. Some 5.7% or C$8.7 billion of the CPPIB's assets were in infrastructure as of Sept. 30, according to the fund's second quarter of its 2012 fiscal year report issued Nov. 10. Currently, the CPP plans to invest C$300 million to C$600 million of equity capital per project, generally by participating in consortiums.

Over the next three years, CalPERS plans to invest up to $5 billion in infrastructure with up to $4 billion of the total invested in the U.S., noted Wayne Davis, a spokesman, in an e-mail response to questions. Of the domestic portion, CalPERS will be investing up to $800 million in California in energy-related infrastructure investments. The $227.5 billion Sacramento-based system already has a 2% infrastructure allocation, with $203 million invested.

Mr. Davis added that in the near term, “the vast majority of investible opportunities will likely be from private and publicly listed investor-owned companies and involve power-generation facilities, energy pipelines and storage, electric transmission and utilities (energy and water), and renewable power generation.”

J.P. Morgan's Mr. Weisdorf said some investors are crazy about wind farms, while others like the risk-return features of solar in the U.S., U.K. and India as well as the prospects for shale gas in the U.S. “We expect the U.S. to switch from oil to gas, and we will need all new infrastructure,” Mr. Weisdorf said.

In the U.K., the main infrastructure investment theme is regulated energy, he added.

Besides energy, at least one firm is investing in sewage companies. As a recent paper by Pewaukee, Wis.-based infrastructure manager Capital Innovations LLC put it: ”Who said sewage is not sexy?”

Even in an economic downturn, people cannot do without water and wastewater facilities, said Michael Underhill, co-founder and chief investment officer of Capital Innovations. “Energy is an interesting sector within the overall infrastructure asset class. (But) energy is only one sector,” he said. “The investment solution for investors is to have water, wastewater, regulated and diversified electric utilities, communication infrastructure (and) transportation, in addition to energy.”

Mr. Underhill said that these sectors have varying degrees of risk and return as well as various degrees of sensitivity to the economy, providing diversification within an infrastructure portfolio.

Many investors are planning to allocate assets to a wide array of subasset classes. In the energy area, sectors of interest to CalPERS, for example, include power-generation facilities, energy pipelines and storage, as well as electric transmission and utilities, according to a September staff memo, when the investment committee decided to make the additional investment.

But in all sectors, investors are striving for the most stable, income-producing projects.

“There's capital available and interest in core strategies all over,” said John McCarthy, managing director and global head of infrastructure at RREEF Infrastructure in London. “What's going on in Europe at the moment is creating all kinds of concerns. There is a general wariness overhanging the markets.”

Mr. McCarthy added that in the past six to 12 months, RREEF Infrastructure has gotten “good flows (of capital) into North American energy, global infrastructure and regional.”

But Mr. McCarthy doesn't agree that direct investing is a natural progression for large institutional investors. “I don't think that's logical for all institutions,” he said, adding that structures of capital will evolve.