Art by Brian Stauffer
PRESIDENT Donald Trump campaigned on a platform to boost US infrastructure investment by up to $1 trillion over 10 years, and reaffirmed this commitment in his inauguration speech, saying "we will build new roads and highways and bridges and airports and tunnels and railways." There's no doubt US infrastructure spending is sorely needed. The American Society of Civil Engineers Report Card for American Infrastructure estimated $3.6 trillion in investment will be needed by 2020 . It gives overall US infrastructure a D-plus, with levees and inland waterways being in the worst shape. The US found just how deficient some levees were when Hurricane Katrina slammed into New Orleans in 2005 and devastated other parts of Louisiana and Mississippi. It ranks as the costliest US natural disaster, with total property damage estimated at $108 billion , according to the National Oceanic Atmospheric Association.
For asset owners, infrastructure investing offers opportunities to access long-term projects, which have steady cash flow, aren't correlated to financial markets, and can be inflation-adjusted. However, direct investing in infrastructure is a relatively new asset class, with a high barrier to entry requiring technical expertise, understanding of its unique risks, and patience.
Trump's administration has revealed few infrastructure plan details, with news reports saying specifics may be released in the spring. On January 24, Senate Democrats unveiled their own transportation and infrastructure plan to spend $1 trillion over 10 years. According to news reports, the plan includes $200 billion for a "vital infrastructure fund" which could be used to finance projects such as the Gateway Program to repair and replace the ancient rail lines and tunnels between New York and New Jersey damaged in 2012's Superstorm Sandy.
A plan floated in October by now-Commerce Secretary appointee Wilbur Ross and Peter Navarro, now head of the White House National Trade Council, for $137 billion in tax credits to generate $1 trillion in private investment, has had a cool reception by economists. However, just the idea of the federal government showing interest in private investment for infrastructure is raising the interest of asset owners.
"Any push on the part of the federal government to make a coordinated effort to get private investment into the US infrastructure market is very intriguing to all investors," said Indra Dhar, an infrastructure investing expert at Cambridge Associates, a global investment firm focused on portfolio management.
Revenue-based infrastructure investments such as toll roads appeal to asset owners because they have long duration, are generally recession proof, have inflation protection, and many have cash flow yields.
"The big, big advantage of infrastructure is the fact that it's a steady-eddy earner. If you're looking at buying cash flow stream, you cannot do better than infrastructure," said Amine Bouchentouf, managing partner of Parador Capital, who advises Mideast sovereign wealth funds on alternative investments, including infrastructure. Private infrastructure investing has been around for approximately 20 or 30 years, but much of it has occurred in Europe or Australia, which have privatized airports, rail lines and other structures. The US lags behind other regions, but is starting to make inroads. A few examples of well-known public/ private partnerships are the lease of the Indiana East-West Toll Road, the Luis Munoz Marin International Airport in Puerto Rico, and the Grand Parkway in Texas.
Ashby Monk, executive director of the Global Projects Center at Stanford University, a research center that focuses on infrastructure, said despite Trump's pledge, most of the work is done by the states. "This is less a federal question than a state question. A lot of the complaints we've received from the asset-owner community is that if you know one state in America, you know one state. You can't go and do a deal in New Jersey and expect to find a similar regulatory environment in California," he said.
That lack of standardization across states is only part of the problem, Monk said, adding that for about 10 years, the center has been trying to to unlock private capital to fix the US' infrastructure problems.
"It's been very challenging because there's so many moving parts There's the local and state governments, there's the union, there's the tax treatment of the muni bonds. On the investor side, there are conflicts of interest, the government challenges, the lack of visibility into the cash flows. What is Trump's magic bullet here to suddenly create a market that is appealing? Right now our market is not that appealing to global investors in infrastructure," he said.
Andrew Claerhout, leader of the infrastructure and natural resources group at the $171.4 billion-Ontario Teachers' Pension Plan (OTPP), said the US still believes that government should provide much of the infrastructure on behalf of citizens.
"Despite the fact the US is the greatest capitalist nation in the world, it's not very capitalist when it comes to infrastructure," he said.
Monk and Claerhout said the tax treatment of municipal bonds also makes states less likely to seek out public/private partnerships.
"The muni tax credit, in which case you're investing in muni bonds tax-free, is a real big subsidization of the status quo… Until that tax credit is reconsidered or altered, I think it will be hard to push the state bureaucracies off that because they get such cheap debt to finance these things," Monk said.
Dhar said there are signs that might be changing, as other public/private partnerships are fixing infrastructure, such as the central terminal redevelopment in LaGuardia airport and the replacement of Goethals Bridge, a toll road that connects Staten Island, New York, to New Jersey. In cases like these, state budgets are too constrained to provide upfront capital to invest.
"This is a market that is growing and expected to take off. The issue has been that, at any point of time in the last 10-15 years, it looked like the market was ready to take off [and didn't]. This time, it seems it really is, that's why there's hope around the Trump administration as well," Dhar said.
It's difficult to predict what infrastructure investments will do better under Trump because it's so early, said Karen Dolenec, a senior investment consultant at Willis Towers Watson.
Before getting excited about infrastructure investing, asset owners may want to wait to see what Trump has in mind. Many of the US' worst infrastructure problems are projects such as levees or highways without obvious user fees to pay back investors. Keith Black, managing director, curriculum and exams, for the Chartered Alternative Investment Analyst Association, said only 5% of US roads are toll roads.
Plus, if the administration seeks "shovel-ready" projects, those might be greenfield projects that are built from scratch, which are risky for investors, he said. Construction delays and cost overruns are one risk, but demand uncertainty is another.
"Once in a while, someone builds a toll road and no one wants to drive on it," he said.
While investors await administration cues, Mark Paris, head of municipal portfolio management and trading at Invesco, said the muni-bond market expects mostly repair-and-replace infrastructure projects will occur, and come at a measured pace rather than all at once.
"There aren't a lot of places in this country where you need a brand-new bridge. It's usually replace the bridge or roadway, or adding capacity. We expect to see a lot of repair-and-replace, with some sort of collection of revenue on that, whether as a toll or a tax to cover the bond," he said.
Asset owners who might want to invest directly in infrastructure need to consider several factors first, the infrastructure experts said. US funds may want to emulate the success of the Canadian funds who pioneered this type of investing, Claerhout said. US plan administrators must realize Canadian funds are structured differently; The structure of Canadian funds separate the sponsors from the management of the fund. In OTPP's case, the Ontario government and the various teachers' unions in the province are the sponsors, but no sponsors sit on the governing board and management team, which keeps the investing side independent, Claerhout said. The governing board and management team are comprised of investing professionals, and the management team is compensated to attract highly experienced professionals, he said.
OTPP's infrastructure portfolio in 2015, the most recent public numbers available, had $15.7 billion in assets at year-end, up from $12.6 billion in 2014. Infrastructure's investment showed a return of 21.4%, compared to the 14.3% benchmark. That asset figure is expected to rise when 2016 figures are released in April. OTPP has invested in infrastructure for 16 years, and Claerhout said they started slowly, first partnering with others by co-investing and learning how to invest privately before eventually being able to do it themselves.
"You can't replicate it overnight," he said. Bouchentouf agreed that it's difficult for newcomers to enter the market, adding that funds who seek this exposure should seek either external managers who focus on infrastructure or owner/operators with highly experienced teams.
"This is a highly fragmented market with a lot of insiders who know a lot more than you do," he said. For example, he said, there was a lot of money lost by investors in North Dakota's Bakken oil-shale fields during the oil boom a few years ago.
"All this noise created such a commotion that it attracted literally everyone with an ax. And people lost their shirts. The market was very hot and flooded by people not experienced and taken away by the mania and hype," he said.
Bouchentouf said his preferred deals are for renovations of existing assets, called brownfield sites, such as new airport terminals, ports and toll roads. Here, investors buy into existing streams of cash flow with the added benefit of future positive cash flow from renovations and upgrades that may mean higher premiums charged.
When talking to municipalities, Black said asset owners should inquire about the cost structure and the revenue model, but also ask the terms of the concession. Can the municipality change terms of the deal, and what is their out clause?
"You need to know what exactly you have to do to maintain and operate the asset, and what leverage does the public entity have if you're not keeping up your end of the bargain," Black said. That's critical, because these deals often are for decades, Bouchentouf and Black said.
"If you think private equity with a seven-year lock-up is illiquid, that's blown out of the water with infrastructure, because we're looking at projects with a 15, 20, 30-year horizon," Bouchentouf said, noting Abu Dhabi Investment Authority's deal for the Chicago parking meters in 2008 is for 75 years.
Because asset owners negotiate with governments, there is headline risk, Black said, which may come into play during contract talks, or possibly when prices are raised or if repairs are needed. Further, whether an asset owner is invested directly in infrastructure or does so through more-transparent listed securities, there are other risks. Christopher Huemmer, senior vice president and senior investment strategist for FlexShares exchange-traded funds, said natural disasters are a risk. If infrastructure is severely impacted, like the San Francisco-Oakland bridge collapse in 1989 or the Fukushima nuclear reactor meltdown in 2011, the asset is greatly devalued. There is also political risk as shifts in regimes may affect how assets are reviewed and regulated.
Ashby echoed OTPP's Claerhout on how asset owners should regard infrastructure investing, starting slowly by perhaps investing in real estate, then working up to co-investing with a manager to build up capacity before diving in.
"This is evolution, rather than revolution. The board of directors, everybody needs to be brought on a journey of education to reflect the underlying requirements," he said.
Bouchentouf said a modest infrastructure investment encompasses 3% to 5% of a portfolio. Funds with the financial wherewithal to invest are those which can earmark about $100 million to $500 million of capital and who are OK with a long lockup. "If you're running around with $25 million and $50 million and investing for five years, this is absolutely not the right market for you," he said.
That might be difficult for many owners, but Monk said for plans that want to commit to the space and are willing to be innovative, one idea is to team up with other asset owners and create an infrastructure alliance. One example is Argo Infrastructure Partners , a $500 million fund created in 2015 and seeded with money from CalSTRS and Crow Holdings, the Dallas-based investment office controlled by descendants of Margaret and Trammell Crow. It invests mostly in energy infrastructure. Dutch pension APG is also said to be a member. "That is totally reasonable and could be done tomorrow. You could get 40 American pension plans, coming together [with] each making a $100 million commitment, which is peanuts, to start funding American infrastructure, and you have $4 billion. I promise you, with a $4 billion fund, we could design it in a way that's completely aligned, is professional, compensates the staff appropriately, and put it to work to try to do deals in America," he said. By pooling capital into a critical mass, investors could be in a better position to get preferred terms from government entities and accomplish more than doing single-project public/private partnerships.
"We would love to see American public pension plans doing it, because when you sell the asset, you're selling it to retirees," Monk said. —Debbie Carlson