Monday, April 25, 2016

Pensions Bankrolling Canada's Infrastructure?

Andy Blatchford of the Canadian Press reports, Liberal government to consider public pension funds to help bankroll mounting infrastructure costs:
The federal government has identified a potential source of cash to help pay for Canada’s mounting infrastructure costs — and it could involve leasing or selling stakes in major public assets such as highways, rail lines, and ports.

A line tucked into last month’s federal budget reveals the Liberals are considering making public assets available to non-government investors, like public pension funds.

The sentence mentions “asset recycling,” a system designed to raise money to help governments bankroll improvements to existing public infrastructure and, possibly, to build new projects.

For massive, deep-pocketed investors like pension funds, asset recycling offers access to reliable investments with predictable returns through revenue streams that could include user fees such as tolls.

“Where it is in the public interest, engage public pension plans and other innovative sources of funding — such as demand management initiatives and asset recycling — to increase the long-term affordability and sustainability of infrastructure in Canada,” reads the sentence in the new Liberal government’s first budget.

Asset recycling is gaining an increasing amount of international attention and one of the best-known, large-scale examples is found in Australia. The Australian government launched a plan to attract billions of dollars in capital by offering incentives to its states and territories that sell stakes in public assets.

Like the Australian example, experts believe monetizing Canadian public assets could generate much-needed funds for a country faced with significant infrastructure needs.

The Liberal budget paid considerable attention to infrastructure investment, which it sees as way to create jobs and boost long-term economic growth. The Liberals have committed more than $120 billion toward infrastructure over the next decade.

Proponents of asset recycling say enticing deep-pocketed investors to join can help governments avoid amassing debt or raising taxes.

“Asset recycling is a way to attract private-sector investment into activities that were formerly, exclusively, in the public realm,” said Michael Fenn, a former Ontario deputy minister and management consultant who specializes in the public sector.

“It’s something that we should pay a lot of attention to and I’m really pleased to see the federal government is looking seriously at it.”

Fenn serves as a board member for OMERS pension fund, which invests in public infrastructure around the world. He stressed he was not speaking on behalf of OMERS or its investments.

Two years ago, Fenn wrote a research paper for the Toronto-based Mowat Centre think-tank titled, Recycling Ontario’s Assets: A New Framework for Managing Public Finances.

In Canada, he said there have been a few examples that resemble asset recycling, including Ontario’s partnership with Teranet to manage its land registry system and the province’s more recent move to sell part of the Hydro One power company.

For the most part, Canada’s big pension funds have been focused on international infrastructure investments because few domestic opportunities have been of the magnitude for which they tend to look.

Australia’s asset-recycling model has been praised by influential Canadians such as Mark Wiseman, president and chief executive of the Canada Pension Plan Investment Board.

“With growing infrastructure deficits worldwide … we often reference this model with our own government and others as one to follow to (incentivize) and attract long-term capital,” Wiseman said in prepared remarks of a September speech in Sydney to the Canadian Australian Chamber of Commerce.

The massive CPP Fund had $282.6 billion worth of assets at the end of 2015. Wiseman’s speech noted more than 75 per cent of its investments were made outside Canada, including about $7 billion in Australia.

Last month, Wiseman was named to Finance Minister Bill Morneau’s economic advisory council, which is tasked with helping the government map out a long-term growth plan. The council also includes Michael Sabia, CEO of Quebec’s largest public pension fund, the Caisse de dépôt et placement du Québec.

In a prepared speech last month in Toronto, Sabia said financial institutions like pension plans have tremendous potential to drive growth through infrastructure investment. For the investor, Sabia said that infrastructure offers stable, predictable, low-risk returns of seven to nine per cent.

A spokeswoman for Morneau’s office was asked about Ottawa’s interest in asset recycling, but she referred back to the budget and said there was nothing new to add on the issue, for the moment.
Last year, I discussed this idea of opening Canada's infrastructure floodgates. Since then, the idea has taken off and there has been a vigorous push from Ottawa to court pensions on infrastructure.

Why does this initiative of "asset recycling" make sense? I've already mentioned my thoughts here but let me briefly make a much simpler case below:
  • Federal, provincial and municipal governments are cash-strapped and they need funds to invest in infrastructure. Increasing taxes to do this is simply not a viable option when the economy is weak.
  • Unlike other investments, investing in infrastructure has huge long-term economic benefits to any country and infrastructure jobs pay well, which means there is an important multiplier effect to the overall economy from these jobs.
  • Pensions need yield. They can invest in public and private markets or in hedge funds. Increasingly, they're avoiding volatile public markets where bond yields are at historic lows and they're even starting to shun hedge funds which promise absolute returns but have failed to keep up with simple stock and bond indexes. 
  • Where are pensions turning to? Private equity, real estate and infrastructure. But unlike private equity, Canada's large pensions invest directly in infrastructure, avoiding hefty fees to general partners (GPs), and unlike real estate, the duration of infrastructure assets is a better match to the duration of their long dated liabilities which typically go out 75+ years. 
  • What else? infrastructure assets are highly scalable, meaning these large pensions can put a huge chunk of money to work in one infrastructure investment instead of many private equity or hedge funds which charge big fees and don't offer safe, predictable returns.
  • Most of Canada's large public pensions target an actuarial rate of 6.3% (nominal), so if Michael Sabia is right and infrastructure offers a stable, predictable and low-risk return of 7-9%, then why not invest directly in infrastructure? It makes perfect sense.
  • Canada's large public pensions are internationally renowned infrastructure investors, investing in airports, highways, ports, and other infrastructure investments all around the world. Their focus has mainly been in Britain and Australia where the rule of law is similar to the one in Canada. 
  • But if the federal government makes public infrastructure available to them here, either through long-term leases or outright sales, then why not invest in domestic projects, foregoing any currency risk or foreign regulatory risk? Again, it makes perfect sense, it's simple logic, not rocket science. 
  • Of course, if the federal government opens public infrastructure assets to Canada's large pensions, it has to do so for international mega pension and sovereign wealth funds too, introducing competition and leveling the playing field. 
  • Typically Canada's large pensions invest in mature infrastructure investments that have been operational for years and offer well-known cash flows, avoiding riskier greenfield projects with uncertain cash flow projections.
  • But the Caisse is dipping into greenfield projects here in Quebec. It can do so because it has hired an experienced team of infrastructure professionals with actual operational experience who have project management experience and have overseen previous greenfield projects.
On this last point, the Caisse announced plans on Friday for its Réseau électrique métropolitain (REM), an integrated, world-class public transportation project. Jason Magder of the Montreal Gazette reports, Electric light-rail train network to span Montreal by 2020:
It will be the biggest transit project since the Montreal métro, but this one will be built and mostly funded by a pension fund.

The Caisse de dépôt et placement du Québec, the province’s pension fund manager, unveiled on Friday a light-rail network it intends to build, with the first stations coming online in 2020.

“Every time you take this train, you’ll be paying into your retirement,” said Michael Sabia, the CEO of the Caisse.

Answering decades of demands for an airport link from downtown, the $5.5-billion Réseau électrique métropolitain will be a vast network linking the South Shore, the West Island and Deux-Montagnes to both the airport and the downtown core.

“What we’re announcing today is the most important public transit project in Montreal in the last 50 years,” said Macky Tall, the president of CDPQ Infra, the Caisse’s infrastructure arm.

Leaving from Central Station, the 67-kilometre network will use the track running through the Mount Royal tunnel, taking over the Deux-Montagnes line — which already runs electric trains — from the Agence métropolitaine de transport. New tracks will be built over the new Champlain Bridge, and link to the South Shore, ending near the intersection of Highways 30 and 10 in Brossard. Two other dedicated tracks will be built, branching off from the Deux-Montagnes line, where Highway 13 meets Highway 40. One track will head to Trudeau airport, with a stop in the Technoparc in St-Laurent. Another will follow Highway 40 toward Ste-Anne-de-Bellevue. The existing Vaudreuil-Dorion train line won’t be affected by the project.

Light rail trains are smaller and carry fewer passengers, but the service will be more frequent than the current AMT service, Tall said.

This is not the pension manager’s first foray into public transit. The Caisse is one of the builders of the Canada Line, a train that links Vancouver’s airport to the downtown area and the suburb of Richmond. It was built in time for the 2010 Olympic Games.

However, Sabia admitted this project represents a much greater risk, since the Caisse is the principal investor and has to recoup both its capital investment and its operating costs. But he’s confident the Caisse will achieve “market competitive returns” on the project.

“We are taking the traffic risk here,” Sabia said. “This is unusual because generally, it’s governments that take that risk.”

Matti Siemiatycki, an associate professor of urban planning at the University of Toronto, said this is a first for Canada, so it’s an untested funding model.

“Internationally, there have been privately funded and financed commuter rail lines, but in most cases, they don’t recover their operating costs, let alone their capital costs,” Siemiatycki said.

He said because it has holdings in engineering, train manufacturing and train operating companies, the pension fund does have an advantage. But he’s not sure it will be enough.

“It’s possible they can realize economies, but it doesn’t take away the fact that most transportation systems in North America are not recovering their operating costs, let alone their capital costs, so that will be the Caisse’s challenge,” he said.

Sabia said the Caisse intends for most of the revenue to come from fares, which he said will be similar to the ones currently charged by the AMT.

“That’s a big chunk of it but, of course, as you know municipalities today have made a public policy decision to encourage people to use public transit,” Sabia said. “We would expect that current practice would continue and contribute to the overall financing of the project.”

Because the trains will be fully automated, Sabia said the operating cost of the network will be low.

The Caisse, which has a real-estate investment division, will also try to recoup some of the investment through development along the line, but Sabia said the bulk of the revenue will come from ridership. The Caisse expects a daily ridership of 150,000, compared with 85,000 that currently use the Deux-Montagnes line, the 747 airport bus and buses across the Champlain Bridge.

The Caisse has promised trains will leave every three to six minutes from the South Shore and every six to 12 minutes on the West Island and Deux Montagnes Line, for the duration of its 20-hour operation schedule from 5 a.m. to 1:20 a.m. The Caisse estimates it will take 40 minutes to take the train from either Ste-Anne-de-Bellevue or Deux-Montagnes to downtown. It will take 30 minutes to go from Central Station to the airport. It will take between 15 and 20 minutes to travel from Brossard to downtown.

Tall said the decision to follow Highway 40 was made because of work going on in the Turcot Interchange. That work would have prevented crews from building dedicated lines for the next five years. He said building along that corridor would also cost $1 billion more because it would require a track dedicated to passenger traffic.

The thorny issue of parking remains unsolved, however. Currently, many stations along the Deux-Montagnes line are over capacity and there is no space to build new parking spots.

Tall said the Caisse will speak with municipalities about this issue and hopes to come up with a solution.
Michael Sabia has gone from being an outsider to a rainmaker in Quebec. When he took over the provincial pension fund, it was $40 billion in the hole. He's managed to grow its asset base by $130 billion since then and is now looking to invest directly in Quebec's infrastructure with this "risky" foray into a greenfield project.

I put "risky" in quotations because unlike that associate professor of urban planning quoted in the article above, I'm more optimistic and think he is underestimating Macky Tall, CEO of CDPQ Infra and his senior team, many of whom have worked on greenfield infrastructure projects and know what they're doing when it comes to managing such large scale projects. No other large Canadian pension fund has as much operational experience when it comes to greenfield infrastructure projects, which is why they typically avoid them.

So, while Sabia garners all the attention, there are a lot of people under him who deserve credit and praise for this huge project. One of them is a friend of mine who has nothing but good things to say about Michael Sabia, Macky Tall, CDPQ Infra's team and the Caisse in general.

No doubt, greenfield infrastructure projects carry bigger risks but they also offer bigger rewards down the road. Will everything go smoothly in this project? Of course not, there isn't one major greenfield infrastructure project that goes off without a hitch but the people working on this project have actual operational experience and a track record of delivering on such projects below budget (which isn't easy) easing my concerns about recouping operating and capital costs.

So, I would tell the media and critics to ease up and have faith in Macky Tall and his team at CDPQ Infra. They are all very experienced and highly ethical individuals who will deliver on this and other greenfield projects if they are asked to in the future. And trust me, there will be no Charboneau Commission on this project which is great news for Quebec's taxpayers.

Below, Jason Magder of the Montreal Gazette discusses the Caisse's $5.5-billion Réseau électrique métropolitain (REM) project. Talk about "Making Quebec Great Again" (my girlfriend came up with that playing on Trump's campaign logo).

Speaking of Making America Great Again, David Walker, former U.S. comptroller general, and former Gov. Howard Dean, (D-Vt.), discussed which candidate has the best tax plan for voters and corporate America on Monday morning on CNBC Squawk Box.

Listen closely to David Walker's response to Gov. Dean's question at the end of this clip where he states the need to "pursue public-private partnerships" and tap into the trillions of "patient capital" from U.S. pensions to invest in America's crumbling infrastructure.

In Canada, we're already there and unlike in the United States, our large public pensions operate at arms-length from the government (got the governance right) and invest directly in mature and now greenfield infrastructure projects. This will hopefully make not only Quebec but Canada great again. I'll end it on that optimistic note.


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