Thursday, February 11, 2016

Ottawa Courts Pensions on Infrastructure?

David Ljunggren and Matt Scuffham of Reuters report, Canada opens talks with pension funds on infrastructure funding:
The federal government is talking to the country’s largest pension funds about investing in billions of dollars worth of infrastructure projects to help stimulate the economy, the Infrastructure department told Reuters on Wednesday.

Prime Minister Justin Trudeau’s Liberals won an election in October on the back of a promise to run three consecutive annual budget deficits of up to $10-billion to help fund investment in infrastructure and will seek to boost that with private funding, sources told Reuters.

The funds are fiercely protective of their independence from political interference and would not be compelled to invest, but their backing for the projects would be a major boost for Mr. Trudeau.

“We are engaging pension funds and other potential partners to find areas of alignment,” a spokeswoman for Infrastructure Minister Amarjeet Sohi said. She did not give further details.

Executives at Canada’s pension funds, which are among the world’s biggest infrastructure investors, say that the projects will need to be structured in a way that limits the risk they take if they are to be lured into backing them.

Traditionally, funds such as the Canada Pension Plan Investment Board (CPPIB) have been reluctant to back “greenfield” projects, which are built from scratch, because of the risk they carry.

Funds usually prefer investing in “brownfield” infrastructure, projects that have already been constructed, executives said.

Mark Wiseman, chief executive of CPPIB, which has $283-billion in assets under management and invests on behalf of the federal plan that covers most working Canadians, told Reuters projects would need to have sufficient scale to be interesting, be overseen by a predictable regulatory regime and carry limited risk.

“That means projects where we are not going to have to take the build-out, greenfield-type risk because we’re not good at being able to assess those. There’s ways to structurally de-risk these opportunities for institutional investors,” he said.

Mr. Trudeau needs to find ways to boost Canada’s flagging economy, which has deteriorated more than expected since the Liberals came to power with economic growth fading, the dollar weakening and oil prices in free fall.

Bankers say private funding for the projects could amount to several times more than that coming from the public purse, and Canadian pension funds, already among the world’s biggest infrastructure investors, would be an obvious source of capital.

The CPPIB, the Caisse de dépôt et placement du Québec (Caisse), the Ontario Teachers’ Pension Plan and OMERS, the Ontario Municipal Employees Retirement System, are already among the top 10 infrastructure investors in the world.

One government source familiar with the matter said officials had also had conversations with institutional investors such as Brookfield Asset Management, as well as the major Canadian pension funds.

“We’ve talked to Teachers’, we’ve talked to Caisse, we’ve talked to OP Trust, we’ve talked to OMERS, we’re talking to CPPIB, most of the Canadian ones. I think the conversations have gone well and there’s lots of interest on both sides to find a way to partner,” the source said.

The source said the talks were exploratory and specific projects had not yet been discussed. Officials have sought advice on setting up the Canada Infrastructure Bank, which Mr. Trudeau had talked about creating during the election campaign to provide low-cost financing for infrastructure projects.

“Our conversations with the federal government have centered around what pension plans, like ours, look for in an infrastructure investment,” OP Trust CEO Hugh O’Reilly said.

The other funds and Brookfield declined to comment.

It is not yet clear if the plans will be announced in next month’s budget and no decisions had yet been taken on how much money will be raised from private investors, sources say.

The Caisse said last year that it would finance, develop and operate major infrastructure projects for the cash-strapped province of Quebec and hoped to pursue other projects internationally.

Executives say the Liberal government is right to invest in infrastructure, believing that monetary policy has exhausted its ability to stimulate the economy.

“Infrastructure makes economies more productive, it gives you more opportunities to grow. Monetary policy is not going to get us out of this slope we’re on,” a senior executive at one of Canada’s biggest three pension funds said.
Last Friday, I wrote a long comment on how Canadian pensions are cooling on infrastructure, quoting senior executives at Canada's large pensions bemoaning the pricing on many infrastructure investments around the world.

Now we find out that Ottawa has been in discussions (read: please help us!!) with Canada's large pensions to help them with their plan to invest billions rebuilding Canada's infrastructure.

This is a smart move on the part of the federal government, a very smart move. I'll briefly share some of my thoughts below:
  • Canada's large pensions are indeed among the world's biggest investors in infrastructure. They've been directly investing in infrastructure over many years.
  • Infrastructure is increasingly becoming one of the most important asset classes for Canada's Top Ten. Why? Just look at what's going on around the world. Sweden's central bank pushed rates further into negative territory and the yield on the U.S. 10-year Treasury bond hit a low of 1.57% on Thursday morning as stock markets around the world plunge. The rising prospect of the new negative normal and ultra low rates for years is going to make it that much more difficult for Canadian and global pensions to make their actuarial return objective. In light of this, Canadian pensions are investing in infrastructure as a substitute to bonds, offering them a relatively safe yield between bonds and stocks over a very long period (in finance parlance, the long duration of infrastructure assets is a better match to pensions' long dated liabilities).
  • Infrastructure assets, however, carry their own set of risks. Among these risks are illiquidity risk, currency risk, regulatory and political risks. All these risks (except of course illiquidity) can be mitigated by investing in domestic infrastructure projects. 
  • Now, the type of infrastructure projects the federal government is talking about are greenfield, not brownfield which are already operating and have known cash flows. These greenfield projects carry their own set of additional risks like wrong cash flow projections, economic cycle risks, corruption, fraud, etc., but if done correctly using PPPs or using the expertise of a Canadian pension fund team with deep operational experience, these type of greenfield infrastructure investments offer very attractive returns for taking such development risks.
  • In Canada, OMERS Borealis is a world leader in developing infrastructure investing as an asset class for institutional investors. But there are others like Ontario Teachers', the Caisse, CPPIB, PSP Investments, AIMCo which are huge direct investors in global infrastructure.
  • The thing that's striking, however, is that most of the people running or working at infrastructure groups at Canada's Top Ten have no operational experience whatsoever in terms of setting up an infrastructure project or running an infrastructure asset. They typically have an investment banking background and are great deal makers but they know very little about what it takes to operate an infrastructure investment. That works great when things are going well but when they turn south, you need people who know how to operate an infrastructure asset. And with few exceptions, these people are very scarce at Canada's Top Ten. Instead, you have a bunch of deal makers bidding up prices of global brownfield infrastructure investments (they talk about 'being disciplined' but that's what they all do).
  • I mention this because the article above cites CPPIB's Mark Wiseman stating they avoid build-out, greenfield-type risk. No kidding, CPPIB is a prime example of what I'm talking about. I even sent a resume of a friend of mine to both Mark Wiseman and Ontario Teachers' CEO Ron Mock, someone with actual operational experience and nothing came out of that. Instead, the Caisse had the brains to hire him and he's very happy there working on greenfield infrastructure projects. When the shit hits the fan on infrastructure assets, you need people with actual operating experience to tell you how to manage those assets properly.
  • The article above also discusses governance and how Canada's public pensions are fiercely independent. True, Canada's large public pensions operate at arm's length from the federal government but make no mistake, they need the federal government as much as the federal government needs them. Also, in the case of CPPIB and PSP Investments, if they don't play nice, the federal government can make their lives miserable even if it's not directly involved in the day to day operations of their funds. 
  • But right now, there is no acrimony. I think everyone is on the same page. The federal government needs to get going on its massive infrastructure spending to mitigate the effects of a deep recession and Canada's Top Ten need to invest in massive, scalable infrastructure projects to fight the scourge of ultra low bond yields for years to come. The discussions are taking place at a high level and I'm sure they're constructive. If this is done right, it will be a major victory for everyone: the federal government, Canada's Top Ten, Canadian pensioners, and most importantly Canadians looking for work to provide for their families
Those are my thoughts in a nutshell. Are there other issues worth considering? Of course, like will the federal government use the expertise of private investors like Brookfield Asset Management and will it also court international pensions and sovereign wealth funds to invest in these greenfield projects?

That all remains to be seen. The good news is Canada has some of the best infrastructure investors in the world and they will be able to offer the federal government some very sound advice as it carries out its much needed spending on Canada's infrastructure.

By the way, you should all read Canada's infrastructure report card. Just like in the United States, there is a desperate need to fix our crumbling infrastructure and we need private and public partnerships to do this properly and at the most reasonable cost.

It's also worth remembering that infrastructure jobs pay decent wages and have an important multiplier effect in the economy. More importantly, investing in infrastructure is a smart way of investing in the long-term prosperity of our country. And unlike the U.S., in Canada there's a lot less political dysfunction when it comes to big spending projects, especially now that the Liberals swept into power (if only they got on to enhancing the CPP too!).

As always, if you have anything to add, feel free to reach out to me at And if our Prime Minister has time, the next time he's in Montreal, I'd be happy to meet up with him, my brother who he knows well from his high school years and my friend to discuss all this and much more, off the record, of course.

Below, Canada's Infrastructure Minister Amarjeet Sohi responds to the deputy critic for rural affairs who wonders why infrastructure spending is targeting Canada's big cities.

The infrastructure minister was much nicer than I would have been if I responded to such an ignorant and asinine question. Canada is facing its worst economic crisis in its post-war history, no thanks to Harper's dumb one way Alberta tar sands bet, and our politicians better get on with buffering the shock.

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