Piling Into North American Infrastructure

Arleen Jacobius of Pensions & Investments reports on how institutions are piling into infrastructure across North America:

Relatively new as an institutional asset class in the U.S., infrastructure is one of the fastest growing real asset classes in North America, albeit from a small base, industry insiders say.

Infrastructure, along with energy, exhibited the most growth of any private asset class among the largest 200 U.S. defined benefit plans in the year ended Sept. 30, according to Pensions & Investments' annual survey.

This trend is expected to continue as investors look for consistent income. Further underscoring the asset class, the Trump administration unveiled a plan as part of its 2019 budget proposal that it said would generate $1.5 trillion in public and private infrastructure investment during the next decade, according to the administration's Rebuilding America's Infrastructure fact sheet. However, the proposal does not include a funding source. In April, President Donald Trump and the Democratic leadership in Congress agreed to a $2 trillion infrastructure plan, but no bill is yet before Congress. And since much of the transportation-related infrastructure in the U.S. is owned by states and local municipalities, industry insiders do not think a federal infrastructure bill will expand the investment opportunity in a major way.

The U.S. sector at the center of the administration's plan is transportation infrastructure — including airports, ports, bridges and logistics — and "much of it is in the hands of local municipalities," said Dylan Foo, San Francisco-based global head of direct investments for the infrastructure team of AMP Capital Investors Ltd., which manages $14.3 billion in infrastructure assets.

Infrastructure funds worldwide have had no trouble attracting a steady stream of capital. Seventy-four infrastructure funds raised $93 billion worldwide in 2018, up from 82 funds that closed on $47 billion in 2014, Preqin data show. In the first quarter, $15 billion was raised by seven funds.

And the funds are getting larger. The average size in the first quarter was $2.14 billion, up from $1.07 billion in the year-ago quarter and $786 million in the first quarter of 2014, according to Preqin. Global infrastructure assets under management totaled $491 billion as of June 2018, up 9.8% from the prior year.

Varying returns

Returns of North American investors vary. For the $358.6 billion California Public Employees' Retirement System, Sacramento, infrastructure was the second-best performing asset class for the one year and the best performing asset class for the 10 years ended Dec. 31, earning 11.3% and 15.2% respectively. CalPERS had $4.6 billion invested in infrastructure as of Dec. 31. The C$111.9 billion ($83.7 billion) Ontario Municipal Employees' Retirement System, Toronto, has a C$20.3 billion infrastructure portfolio that earned a 10.6% net return in 2018, according to its annual report.

But competition for infrastructure deals by domestic and international investors and the advent of mega infrastructure funds with massive amounts of capital are expected to compress returns, said Andrew Deihl, Charlotte, N.C.-based head of energy and infrastructure at Nuveen. For example, Brookfield Asset Management and Global Infrastructure Partners are both raising new funds with $20 billion targets, according to Preqin. IFM Investor Pty Ltd.'s last infrastructure fund closed in 2017 with a then record $15.8 billion. Brookfield's earlier infrastructure fund closed in 2016 with $15 billion.

About half of the current deal flow in the real assets market is power infrastructure, with 40% in energy and 10% in natural resources such as timberland and agriculture, said Kevin Warn-Schindel, Boston-based managing director and head of real assets at funds-of-funds and secondary market alternatives manager HarbourVest Partners LLC.

Of the deals HarbourVest assessed in 2018, there were $29 billion in real asset secondary transactions, up from $17 billion in 2017 and less than $5 billion per year in 2013 and 2014.

Natural resources is the smallest component of the investible real asset universe, Mr. Warn-Schindel said. Investors in timber and agriculture, both part of natural resources, tend to be more income-oriented, while investments in upstream mining, another natural resources strategy, tend to have more development risk ,placing it at the riskier end of the efficient frontier, he said.

When it comes to infrastructure transactions, North America is in catch-up mode. Europe has seen the most infrastructure deals each quarter since 2014 except for a few quarters when North America topped the transaction list, Preqin data show. In the first quarter of 2019, for instance, there were 188 infrastructure transactions in North America, compared to 180 in Europe, 54 in Asia and 86 in the rest of the world.

Even so, four of the largest infrastructure funds in the market, including the two largest each targeting $20 billion — Global Infrastructure Partners IV and Brookfield Infrastructure Fund IV — aim to invest in the U.S.

And more infrastructure investors are based in the U.S. (43%) than Europe (33%) or the Asia-Pacific region (18%) in 2018, Preqin data show.

Most go with managers

While many North American investors are investing directly either outright or in co-investments, Julio Garcia, New York-based head of infrastructure-North America for IFM Investors, said the "majority of the investment in the asset class by (North American) investors is still fulfilled by investing in infrastructure funds managed by third-party managers. Although there is an increasing interest in other arrangements, most of the transactions in the market continue to be executed by the specialized managers of commingled funds."

And even with several megafunds in the market, some large direct deals have been announced this year.

In March, the C$392 billion Canada Pension Plan Investment Board, Toronto, and Tulsa, Okla.-based infrastructure operator The Williams Cos. Inc. formed a $3.8 billion joint venture that will include Williams' Ohio Valley Midstream system and its Utica East Ohio Midstream system. CPPIB invested about C$1.34 billion for a 35% stake in the joint venture. Williams will own the remainder.

CPPIB had C$33.3 billion in infrastructure assets as of March 31.

Institutional investors, especially Canadian asset owners, are beginning to compete with infrastructure managers for some deals, said Alina Osorio, Toronto-based president of Fiera Infrastructure Inc. The C$309.5 billion Caisse de Depot et Placement du Quebec, Montreal; C$97 billion Ontario Municipal Employees' Retirement System, Toronto; and C$153 billion Public Sector Pension Investment Board, Ottawa; are joining sovereign wealth funds worldwide and superannuation plans in Australia in the market, she said.

"There's a lot of money chasing opportunities at the top end of the market," Ms. Osorio said. Fiera invests in the middle market, focusing on projects capped at $1 billion in enterprise value, where there is less competition, she added. Fiera Infrastructure had C$1.7 billion in AUM as of April 30.

North American asset owners are not the only institutional investors interested in direct investment on the continent. In May, GIC Pte. Ltd., Singapore's sovereign wealth fund with assets estimated at more than $350 billion, took a minority stake in $2.8 billion WaterBridge Resources LLC, a water management network and a portfolio company of Five Point Energy LLC, a Houston private equity firm focused exclusively on the midstream energy sector. WaterBridge's network gathers and treats water produced from shale wells to be recycled and reused by oil and gas producers.

"GIC has an extraordinary long-term view and is investing in assets that are long term, cash-flowing and stable," said David Capobianco, CEO and managing partner of Five Point Energy. "We approached them with the idea of becoming partners in (WaterBridge)."

WaterBridge was the result of two investments Five Point made in 2017, he said. In mid-2017, it bought water-gathering assets with the purchases of EnWater Solutions and Arkoma Water Resources in the Delaware Basin, located in southeast New Mexico and southwest Texas. "We ultimately pioneered a new midstream industry that did not exist before," Mr. Capobianco said.
Energy dominates

In North America, infrastructure assets are mostly in energy. In May, IFM acquired a publicly traded master limited partnership, Houston-based Buckeye Partners LP, which owns and operates a network of integrated midstream energy assets in the U.S., including 6,000 miles of pipeline to transport oil and gas.

Overall, there has been a lot of investment in energy and midstream energy infrastructure projects over the past couple of years, said Stacey Morris, Dallas-based director of research at Alerian, a provider of energy infrastructure and MLP indexes.

There's been a pickup over the last 12 months mainly because energy infrastructure companies are fee-based businesses with cash flow for investors, Ms. Morris said. "It's a way to play oil and gas and natural gas with less commodity exposure than investments in oil and gas exploration and production," she said.

Oil price fluctuations from more than $100 a barrel in 2011 to the bottom of $26 a barrel in 2016 hurt the energy infrastructure sector, resulting in underinvestment, Ms. Morris said.

But for IFM, infrastructure is more than just energy. "In the last 12 months, IFM has committed over $1.6 billion to transportation-sector opportunities in the U.S. and Canada while also being active in the midstream energy space," IFM's Mr. Garcia said. The firm has $39.1 billion in infrastructure AUM.

While investment in utilities is also a focus for IFM, Mr. Garcia said utility valuations are too high to provide an appropriate risk-adjusted return at this point in the cycle.

In the U.S. in particular, transportation infrastructure investment opportunities are large, scarce and highly competitive because most of the roads, bridges and airports are government-owned and had been traditionally funded by municipal bond proceeds, industry insiders say. In Canada, a smaller market, public-private partnerships are more prevalent in transportation as well as water, wastewater, hospitals and data centers.

"Public-private partnerships have been a big part of our investible market (in Canada) for a while," Fiera's Ms. Osorio said. "A lot ... are at the provincial level. That's where we've seen international players," she added.

This is an interesting article which shows you how institutional demand for infrastructure is on the rise.

Unlike Canada's large public pensions, most US pensions are investing in commingled infrastructure funds.

You can see a list of the top 50 infrastructure investment managers here and below:

I also embedded an image of the top 10 infrastructure managers:

Among the list, I personally consider Brookfield's infrastructure fund run by Sam Pollock to be the best infrastructure fund in the world, but there are other great managers and competition is fierce.

CalPERS recently committed $1.5 billion in two infrastructure funds:

California Public Employees Retirement System, Sacramento, committed $1 billion to GIP Strategic Alliance SMA I, a separately managed account managed by Global Infrastructure Partners. The portfolio focuses on core infrastructure in developed markets including the U.S.

Separately, CalPERS committed $500 million to JP Morgan Infrastructure Investments Fund, an open-end infrastructure fund managed by J.P. Morgan Asset Management.

Now, while I understand why CalPERS is investing in infrastructure funds, one expert I spoke with shared this: "This is an example of how to use your scale in a completely undifferentiated way."

I agree, infrastructure funds make sense for small to medium-sized pensions who want exposure to the asset class, but when you're the size of a CalPERS, you're better off  going direct internally or if you lack the internal capability, invest in a platform where you partner up with an experienced manager who is essentially a captive manager (offering you better fees, knowledge transfer and so much more).

And for small to medium-sized pensions, I wouldn't only look at megafunds, I'd look at smaller funds like Fiera Infrastructure and partner up with a firm like CBRE Caledon Capital run by David Rogers.

I'd also invest with Andrew Claerhout, the former head of Infrastructure and Natural Resources at Ontario Teachers' Pension Plan, an experienced professional who was successfully managing the asset class at OTPP and is someone who understands the future of infrastructure investing.

Andrew recently shared this with me on his infrastructure platform called Atom:

When I set out on this journey I did so hoping to find an anchor investor (or a small club of anchors) that could commit a sizeable amount of capital to the fund to stand it up and de-risk a broader fundraise. The elevator pitch to these investors was that they could invest in scale (e.g., $300 million towards a $1 billion target) in a segment of the market that they would not be able to access directly (i.e., mid-market core plus and value add infrastructure) and do so cost-effectively both through the discounts in management fees and carried interest they would receive from their minority ownership stake in the fund and from fee and carry free co-investment. Furthermore, given their close working relationship with the fund as a minority shareholder, they would be able to affect knowledge transfer. Said differently, they could leverage the fund as an additional set of eyes and ears in the market.

While I continue to speak to a number of LPs about anchoring the fund, another idea I have started to explore is developing Atom into as a captive platform company. So rather than thinking of Atom as being a fund, with an anchor that receives preferred economics, Atom could be a portfolio company of the investor where the sponsoring institution is the controlling shareholder. This would provide a large institution (such as CPPIB) the ability to put that much more capital to work and have that much more control.

The advantage of anchoring Andrew's platform, is you partner up with someone who knows the asset class very well, will provide knowledge transfer, co-investments from the onset and attractive terms because it will be a captive platform company.

In infrastructure, you're better off going direct, especially if you're a large pension that can scale and commit substantial resources to the asset class. If you can't go direct, invest in a platform and gain valuable knowledge transfer and co-investment opportunities form the get-go.

Infrastructure Investor just published a great comment, The price of direct investing, which you can all read here (subscription is required, I thank Andrew Claerhout for sending me the comment).

I leave you with a table that looks at the returns of infrastructure over last two years at five of Canada's large pensions:

Infrastructure is still offering great returns but competition is impacting performance and some pensions are feeling it more than others.

I wouldn't read too much into this table, just showing it for illustrative purposes and it's important to note that there are a lot of reasons that can explain discrepancy in performance from one year to another or from fund to fund.

Below, Mathias Burghardt, CEO and founder of Ardian Infrastructure discusses the approach and strategy of Ardian funds in the US, offering excellent insights.