Investment in P3 infrastructure continues to be a major global trend, and public pension funds are emerging as key players. As I report in the “Transportation Finance” chapter of Reason Foundation’s Annual Privatization Report 2016, infrastructure equity investment funds over the past decade have raised approximately $350 billion to invest as equity in all forms of infrastructure. At a typical 25% equity/75% debt ratio, that would support $1.4 trillion worth of projects.
Two of the 30 largest global infrastructure investors, as ranked by Infrastructure Investor, are public pension funds: Australia’s IFM Investors (#5) and Canada’s Borealis Infrastructure (#7). Australian and Canadian pension funds were first-movers among pension funds, these days devoting about 5% of their portfolios to infrastructure. By contrast, U.S. pension funds are just getting started, with the larger ones still seeking to reach initial targets of 1-1.5% of their portfolios.
But U.S. funds are increasingly moving in this direction. The reason is simple: in today’s very low interest-rate environment, they find it difficult to achieve their needed 7-8% overall return on their investment portfolios. Hence, as Reuters reported in June, “More U.S. public pension funds are looking to buy real assets for their portfolios, seeking cash-generating, stable investments in this low-interest environment.”
In a long post on June 14th, Pension Pulse provided more specifics on why major funds like CalPERS (which recently bought a 10% stake in the Indiana Toll Road concession) are moving into this sector. It first noted that “The number of institutional investors with stakes in infrastructure has more than doubled since 2011 to more than 2,750 from 1,300,” and that among the top 10 public pension funds investing in infrastructure, “allocations more than quadrupled over the past five years to $17.7 billion.” It then reminded readers that “The long life cycles of road, airport, and energy projects correspond well with funds’ long-term liabilities.” And, “there’s also the allure of inflation protection, as toll revenues often rise at a similar pace.”
Analyst John Ryan of Greengate LLC produced a detailed report on this subject for McGraw Hill Financial’s Global Institute, “The Public Pension Core Funding Gap and Infrastructure Public-Private Partnerships.” It goes deeper into what makes for a good fit for pension funds. He draws a distinction between P3 concessions entered into for “traditional” reasons (such as to gain efficiencies from smarter procurement) versus those entered into for financial motivations (e.g., monetization of the asset value of existing, often aging, infrastructure). Ryan concludes that the latter cases generally provide a better fit for pension funds, for two main reasons:
1. A much larger supply of projects, since the need to reconstruct and maintain aging infrastructure is much greater than the need to create brand new facilities.
2. Greater return on investment, assuming the concession structure is financed based on revenue-risk, rather than availability payments.
When I read this section of Ryan’s report, my immediate thought was Asset Recycling, under way in Australia and being seriously considered today in Canada. As I wrote in my column in the March issue, the idea is that governments unable to afford needed infrastructure investments can lease existing airports, highways, seaports, etc. under long-term concession agreements, a la the Indiana Toll Road. The proceeds can be used for other infrastructure investments that do not lend themselves to user-fee financing (e.g., public buildings or local roadways).
The recent buyouts of the Chicago Skyway and Indiana Toll Road concessions by pension funds offer a paradigm case. In sharp contrast to the original highly leveraged deals (that were vulnerable to revenue declines during the Great Recession), the pension fund deals both featured more than 50% equity. That’s because pension funds—unlike hedge funds and investment banks—are very happy with single-digit returns of 8% or so, which are quite feasible with conservatively financed concessions.
And this has profound political implications. One of the objections raised by opponents of the original Skyway and ITR concessions was the specter of enormous toll rate increases, so that the investors could achieve hoped-for double-digit returns. The same argument is being raised today by some of Canada’s airport authorities, in response to the new government’s consideration of privatizing major airports. And just imagine the concerns that might be expressed if LAX or JFK Airport were to be put on the market in this country.
Having major public employee pension funds as key investors in such deals would be a big political plus, since the reason for their investments would be to rescue their current and future public-servant retirees from the threat of slashed pension benefits. And their lower return-on-investment targets would also be a plus. It’s interesting to note that most U.S. unions (apart from the militant Caltrans engineers’ union PECG) have figured out that P3 infrastructure investment is in their members’ long-term interest. Besides CalPERS, other large U.S. pension funds investing in P3 infrastructure include those of state employees in Arizona, Florida, Illinois, and New York City, as well as university-oriented TIAA. Three large Canadian pension funds recently submitted the winning bid for the UK’s London City Airport.
Those PWF readers who are mostly focused on greenfield P3 projects may see this discussion as oblique to their interests. But consider that a 50 to 75-year concession for an existing airport or Interstate highway will assuredly require major additions and/or reconstruction during the life of the agreement. The more such assets that are privatized via revenue-risk P3 concessions, the more businesslike their managements will be, and their user-fee revenue sources will be available when the time comes to do those projects.
In my view, pension fund investment will likely be the key that unlocks US asset recycling, greatly expanding the market for long-term revenue-risk concessions.
Robert Poole is director of transportation policy at Reason Foundation, where he’s advised four presidential administrations on transportation issues.