In the past year, despite public and political discussions about the need for massive improvements to roads, bridges, public transportation systems and other infrastructure elements in the U.S., public-sector investment in infrastructure projects reached its lowest point since the Great Depression. Meanwhile, airports, highways, water treatment plants, and electricity and energy delivery systems continue to be neglected amid growing budget deficits.
Gross capital investment by the public sector — which also includes funding of research and other projects — has dropped to 3.6% of U.S. gross domestic product compared with a postwar average of 5%, according to figures from the Bureau of Economic Analysis. The American Society of Civil Engineers has estimated $3.6 trillion needs to be invested over the next seven years to bring the nation's infrastructure up to a level with which the ASCE feels comfortable.
Meanwhile, a similar (and seemingly unrelated) negative trend is taking place in the pension fund industry. Underfunded plans face enormous payouts to beneficiaries in the near future. Unfortunately, returns from traditional investments, especially fixed income, aren't enough to bridge the gap.
Why not help solve these two problems simultaneously by allowing — even encouraging — more private funds to invest in infrastructure projects? Some of these projects have high risk-adjusted returns for pension fund investors. Plus, they fuel the U.S. economy by creating good-paying jobs and necessary infrastructure improvements that allow businesses, both small and large, to flourish.
There's ample room for pension plans to increase their allocations to infrastructure. According to an Office for Economic Co-Operation and Development study in 2011, the latest available, less than 1% of pension assets worldwide is invested in infrastructure projects, excluding indirect investment in infrastructure via the equity of publicly traded utility and infrastructure companies.
Unlike bonds, which are subject to interest rate and inflation risk, the long operating lives of infrastructure assets — and their natural monopolies in most areas — provide reliable long-term cash flows with inflation protection. Their returns are typically uncorrelated with other asset classes, adding to a portfolio's diversification. Many of these investments can be viewed as having better risk-return characteristics than long-term Treasury bonds, especially as the Federal Reserve begins tapering its bond purchases.
Despite the benefits, there are several reasons pension funds historically have overlooked or shied away from infrastructure investing. Many characteristics of the investments, including liquidity and return profiles, make it difficult to determine where the allocation fits within the overall portfolio. There has been a shortage of data on overall performance of infrastructure investments, making it difficult for managers and consultants to benchmark. There also has been a historical perception that certain projects, including oil and gas pipelines, have a negative profile by the public, not to mention real opposition from labor unions to privatization of infrastructure.
What's more, the overall market for infrastructure investing in the U.S. remains immature and has not provided many opportunities to investors, according to the OECD study. The development of public-private partnerships has been slow and problematic. As a result, privatization of transit infrastructure (e.g. roads, bridges, and tunnels) has lagged behind Australia and Europe. There is also little direct private investment in the nation's highway and transit systems because of the current method of financing infrastructure mainly based on municipal bond markets.
Nevertheless, some of these challenges have grown easier to overcome. Private equity firms and other experienced managers have started pooled investment vehicles to invest in projects. Track records of existing funds have become lengthy enough to provide comfort to consultants.
Public perception of public-private partnerships is slowly becoming more positive as word has spread about the success of past deals. Unions actually have begun joining in many infrastructure deals led by experienced asset managers. In 2009, The Carlyle Group closed a $178 million deal to buy and develop 23 highway service stations in Connecticut with the help of the Service Employees International Union.
Given these changes and the huge infrastructure requirements, the U.S. needs involvement from investors such as pension funds. The fiscal deficit in many cities and towns across the U.S. is likely to drive policy actions toward adoption of PPPs and other private-sector solutions. And, the need for alternative sources of capital for these projects might also spur positive support from prior adversaries.
We expect asset managers and experienced infrastructure investors to begin raising new capital and looking for allocations from pension plans and other institutions. In late 2011, the Transportation Infrastructure Finance and Innovation Act was enacted to help spur PPPs for transportation projects by drawing more private equity and debt capital into infrastructure development as well as establishing voluntary, uniform frameworks across states for PPP projects.
But TIFIA is only a $50 billion program and focuses largely on transportation. Much more needs to be done to encourage infrastructure investing. We hope pension funds, consultants and other institutional investors encourage investment managers to provide innovative opportunities to invest in infrastructure, something from which everyone can benefit.
Nicholas Tsafos is a New York-based audit partner in the financial services group of EisnerAmper LLP, an international accounting and advisory firm.
