Institutional Investors, Asset Recycling, and the US Infrastructure Agenda

Infrastructure is a hot topic in the upcoming fourth coronavirus stimulus package, and the world’s wealthiest asset managers, bearing an appetite for portfolio resiliency and diversification, could be of great assistance.
Reported by Steffan Navedo-Perez

Art by Yiqing Zhang


At this point, it’s no secret that there is strong bipartisan support to fix the United States’ “crumbling infrastructure,” and the president repeatedly tweets for “BIG and BOLD” action on the expensive issue. Especially now, with US interest rates at nearly 0%, Congress is entertaining the thought of including a substantial infrastructure package in its fourth coronavirus stimulus package, saying it can maintain America’s economic competitiveness and connect communities and people to more opportunities.

Infrastructure was one of the first campaign promises President Donald Trump reiterated after his win on election night. It is, however, one of the few legislative aspirations that’s received exceptional support from both Republicans and Democrats but is yet to be agreed upon and passed. It’s still unclear how the administration wants to go about repairing and modernizing the state of the country’s infrastructure, but it has expressed clear support for asset recycling, a popular development method in Australia that incorporates the large pools of capital allocated by institutional investors.

What is asset recycling? It’s a method that includes a local government’s sale or lease of existing infrastructure assets, under strict and transparent regulation, and uses the capital from the transaction toward the development of new infrastructure. The Australian federal government incentivized this by promising a stipend equitable to 15% of the transaction’s value to the local government from the $5 billion Asset Recycling Fund.

An illustration of the asset recycling model. The terms brownfield and greenfield are used to define existing projects and projects under development, respectively.

Source: The Reason Foundation

Asset recycling was also considered in the US as part of a comprehensive infrastructure package introduced to Congress in 2018 by a team that included the first Special Assistant to the President for Infrastructure and a senior operating partner at Stonepeak Infrastructure Partners, DJ Gribbin.

Gribbin worked to develop the administration’s infrastructure policy and focused on expediting the delivery of projects and raising revenue for them. He and his colleagues pushed forward a $1 trillion infrastructure proposal in early 2018 that included incentives to local government agencies who would participate in asset recycling and other revenue-generating ideas.

“Our approach differed from Australia in that instead of incentivizing only asset recycling, we provided an incentive for any form of new revenue, including asset recycling. We were seeking to stimulate much more new investment in infrastructure than asset recycling would generate on its own,” Gribbin told CIO.

“We essentially said to owners of infrastructure, county, state, and city authorities, if you generate new revenue for infrastructure, the federal government will pay you for that revenue generation, similar to the approach taken in Australia for asset recycling. Whether the new revenue took the form of a tax increase, rate increase, or asset recycling,we let the owners figure that out. So, it wasn’t an incentive just to recycle assets, it was an incentive to do anything creating new revenue for infrastructure.”

Feedback was largely positive from his discussions on the idea because it helped incentivize local governments to raise revenue to address their overdue infrastructure concerns.

“The states were very supportive of it, and cities and counties as well. It’s very hard politically for them to raise new revenue, and what we did is  provide another incentive that helped governors and mayors go to their constituencies and say ‘all right, we’re going to do this difficult thing in terms of raising revenue but if we do it the federal government will give us [the incentive payment],’” Gribbin told CIO. The bill failed to gain substantial traction after 2018 congressional elections ushered in new lawmakers who had different plans for the issue.

Infrastructure developments are important because they help to sustain the long-term growth and stability of the communities they serve, and any additional capital to fix such a relatively expensive problem could potentially help get the ball rolling on fundraising.

“It’s fair to infer a positive correlation between the state of a region’s infrastructure and the vitality of its economy,” says Tradewind Interstate Advisors Managing Partner Clive Lipshitz. He added that the synchrony of progress between infrastructure and economic growth is sometimes referred to as a “virtuous circle.”

“If infrastructure leads to job growth and a stronger tax base, that is ultimately good for pension systems … [and] the ultimate guarantor of pension solvency is the taxpayer,” Lipshitz told CIO.

CIO previously explored the defensive characteristics that infrastructure investments can provide to supplement the resiliency of an institutional investors’ portfolio, among them being a low correlation with equities, inflation protection, and revenue streams largely out-of-sync with the economic cycle.

Don’t Forget to Recycle!

The trend really kicked off in Australia in the 1990s, when a consortium of developers and investors took over the country’s Sydney Harbour Bridge and subsequently spearheaded the development of a new tunnel under the existing harbor tunnel, then took the capital from the projects to develop the Sydney Harbour crossing. The back-to-back transactions illustrated a clear revenue stream from the initial sale to the eventual development of a new asset, helping to solidify the concept of asset recycling among the country’s citizens and bringing it into practice.

Institutional investors are well-suited to participate in asset recycling initiatives across international markets. Investors with previous history in the strategy include Canada’s Caisse de depot et placement du Quebec (CDPQ), Australian Super, First State Super, the Ontario Municipal Employees’ Retirement System, the Ontario Teachers’ Pension Plan, and others, according to Inframation Group, a private infrastructure investment intelligence company.

Source: Inframation Group, an Acuris Company

Asset recycling is largely beneficial to all stakeholders in the process; the government saves capital and makes progress toward completing its infrastructure agenda, investors gain access to the broad diversification characteristics of infrastructure assets, and society experiences an enhanced state of long-term economic activity.

“Arguably, no other tool holds as much promise in addressing America’s infrastructure deficit, while simultaneously boosting employment and GDP growth,” said the Reason Foundation, an organization seeking to influence the frameworks and actions of policymakers. “Asset recycling should be part of any solution to rebuild and modernize this country’s aging public-purpose infrastructure.”

Historical activity argues that the 15% bonus worked well to incentivize some local Australian municipalities to work on selling their assets to the private sector. New South Wales, for example, allocated about AUD $6 billion to new projects between 2013 and 2016, without raising additional public debt.

“Absent such an incentive, these governments may not see the value in undertaking these kinds of transactions, given their relative novelty and perceived complexity,” the Reason Foundation said.

Former Treasurer of Australia and Australian Ambassador to the United States Joe Hockey was instrumental in the development of his country’s Asset Recycling Initiative. He publicly advocated for the US to consider his country’s asset recycling program at the Federal P3 Conference in Washington D.C. 

“There are now more cranes and tunnel boring machines in Sydney than in any other city in the world, and the ACT government is building a new light rail system for Canberra, paid for out of the proceeds from selling its lottery office and public housing,” Hockey said.

Concept art of the upcoming A$600m Parramatta Light Rail, a project made available in New South Wales through the Australian government’s Asset Recycling Initiative.

Source: New South Wales, Australia Government.

“Governments haven’t got the money [to build new infrastructure],” he added, “and it’s going to get a lot harder in the United States. The federal government owns about 8% of all US infrastructure but funds 14% of it. The federal government’s ability to fund additional infrastructure is constrained by its own growing debt.”

“But while government’s ability to finance and maintain infrastructure is highly constrained, the private sector, as it so often does, is stepping up to the plate,” Hockey said. “[However], there is a lack of political will to engage with the private sector on infrastructure in the same way that many other countries have engaged.”

Australia paused its asset recycling initiative a few years ago due to the federal government’s fiscal constraints, but its popularity was maintained among the institutional investor community while it was still operational.

Mark Machin, president and CEO of the Canada Pension Plan Investment Board, praised the model and said it serves as one that countries around the globe should seek to emulate, bridging the gap between investors that favor mature assets and the need for riskier new infrastructure projects.

“It’s excellent policy,” he was quoted as saying by The Globe and Mail. “They’re getting tremendous interest and tremendous value from international capital and domestic capital.”

Why the American Absence in Asset Recycling?

If asset recycling is touted as a successful program that has the potential to do well in the United States, and the federal government publicly voiced support for the plan, why hasn’t it been implemented to an extent comparable to Australia? There have been a few examples here and there, such as the sale of the Indiana Toll Road in 2006, when the government used the proceeds from the sale to construct hundreds of miles of new roads and interchanges, as well as allocating capital toward the maintenance of infrastructure in the future.

The Indiana Toll Road, sold as part of an asset recycling initiative by the Indiana Finance Authority.

Source: ITR Concession Co.

One obstacle to widespread implementation of asset recycling is the wide variety of jurisdictions and infrastructure owners across the United States. There are thousands of state and county governments that would be responsible for selling or leasing their assets, and getting all of them to think in unison on a new idea could be a challenge.

“The fragmentation of ownership in the United States is a huge barrier to the implementation of an asset recycling program,” Gribbin told CIO. “A project proponent has to deal with so many different owners and the politics makes it very complicated. In the course of public-private partnership history in the US, there’s just an embarrassingly large number of transactions that fell over because politics went the wrong way, and the likelihood of that happening on any particular transaction is incredibly difficult for anyone who’s outside of the jurisdiction to gauge.”

“Don’t focus on asset class, focus on the governmental CEO or the owner,” Gribbin said, when engaging in a potential infrastructure asset sale. “Investors tend to say, ‘We want airports,’ but it doesn’t really matter–find a leader like John Hickenlooper, who is the former governor of Colorado, and work with that leader to identify assets they control that would be good candidates for public-private partnerships or recycling. Find the best owner, find the owner that’s most inclined to transact, and talk to them about what they are interested in transacting on.”

The sentiment of Paul Shantic, director of the Inflation Sensitive portfolio at the California State Teachers’ Retirement System (CalSTRS), largely falls in line with Gribbin’s opinion on the fragmentation of the legal network in the country. “Infrastructure development in the United States is a local and regional market and not standardized in terms of project development and cost determination. There is not a model that fits all of those entities in terms of infrastructure development and procurement.”

The Alaska Permanent Fund Corporation’s Chief Investment Officer Marcus Frampton’s perspective falls largely in line with Shantic’s. “There’s so much municipal-owned infrastructure in the US, if ownership were more centralized, it might be conducive to smart policy,” Frampton told CIO. “We may be so decentralized here that it’s an impediment to coordinated strategies like [asset recycling].”

“It makes all the sense in the world to do it,” Frampton added.

Others hypothesize that the concept of privatizing a public-use asset can be a potential obstacle to legislative approval of an asset recycling program in the US.

Law firm Buchanan Ingersoll & Rooney said, “Taxpayers may be wary of a private company taking over operations of a public asset with the goal of generating revenue for itself. Even if the private company can show that it will operate the asset more efficiently, save money in the long run, and generate immediate revenue for the public to use on more pressing infrastructure needs, it can still be a challenge to convince the masses that [asset recycling is] in the public’s best interest.”

“One way to manage public perception is to be firm and transparent in the clauses that a prospective private investor must abide by if successful in a bid,” law firm Marsh & Mclennan said in a report. “These can be set out at the time the asset is identified publicly as a potential asset for recycling and should include clear protection for government employees and end users.

“If these concerns are not proactively addressed, it can lead to situations where public opinion is already firmly entrenched against a potential program, before any debate has really begun,” the company added.

Gribbin noted that he has never experienced a procurement “where the owners drew that distinction” between selling an asset to a private fund manager versus a public entity such as a public pension fund, or otherwise.

“The greater concern from an owner’s standpoint is how experienced [the potential purchasers are] in running this asset and whether they will do a good job,” Gribbin said.

Related Stories:

The Untapped Potential of Infrastructure Investments’ Influence on Humanity

Why Now-Reviled Stock Buybacks Will Rise Anew

CIO Roundtable: How Top Asset Allocators are Dealing with Today’s Volatile Market

 

 

 

 

 

 

 

 

Tags
asset recycling, Australia, brownfield, greenfield, Infrastructure, M&A, stimulus plan,