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Infrastructure Maven -- Barron's

25 Feb 2017 11:01 am
By Reshma Kapadia 

There's one subject that President Donald Trump, foreign leaders, and investors all agree on: the need for infrastructure investments.

The Trump administration's $1 trillion proposal to rebuild America's airports, bridges, and roads is similar to plans in Canada, Australia, India, and Indonesia. And with institutional investors looking to diversify their portfolios and generate income, infrastructure financing has become a hot new market. Many are turning to unlisted funds that pool money to do just that. As a result, these funds raised a record $59 billion last year, according to alternatives research firm Preqin.

Then there's Cressida Hogg, who oversees the Canada Pension Plan Investment Board's $24 billion Canadian ($18 billion U.S.) infrastructure portfolio. Hogg, who had a 20-year career in private equity before joining the CPPIB in 2014, takes direct equity stakes in projects around the world, from toll roads in Chicago and Mexico City to a railroad operator in Australia.

The fund typically invests C$500 million to C$2 billion in a single project, which provides more control than an investment in an unlisted fund. It also means the CPPIB can get into the weeds, helping management fix operational issues. This approach has generated returns for the infrastructure portfolio of 12.8% annually over the past five fiscal years. Unlisted infrastructure funds have returned an average of 10%, though the comparison is not apples-to-apples.

Individual investors can get a piece of the infrastructure action through the $3.7 billion Lazard Global Listed Infrastructure fund (ticker: GLIFX). It has a five-year average annual return 16%. The minimum investment is $100,000. Annual expenses are 0.96%.

We telephoned Hogg in London to talk about how infrastructure differs from other alternative investments, Trump's infrastructure plans, and why India, for all its faults, is a perfect match for pension investments.

Let's start with what makes infrastructure different than other alternatives, like hedge funds or private equity.

Hogg: Infrastructure has lower volatility and more predictable performance through an economic cycle than some of the other asset classes. It also can provide some inflation protection and generate strong cash yields, which is attractive to pension funds like us. We look to take stakes in asset-intensive businesses with strong market positions, sometimes underpinned by regulation. One of the benefits is that it doesn't have a high degree of correlation to the market across a cycle. That is why we invest in private projects, or occasionally in a business we think may become private over time.

McKinsey Global Institute projects that the world will need to spend $57 trillion on new infrastructure by 2030. That sounds like a bounty for infrastructure investors.

We have to be clear about what people mean when they say infrastructure. Most new infrastructure projects are built by governments. When McKinsey talks about an infrastructure-spending gap, much of that will be filled by public sector money, out of tax revenue.

Should investors cool their excitement?

These plans are not going to cause a wall of short-term opportunity for investors like us. But providing better quality infrastructure is a good thing for countries because it underpins macroeconomic growth. And over time, I believe many public projects will turn into private projects. There's a clear track record of governments bridging the risk of constructing infrastructure and then, once they are proven and operational, transferring assets into private hands through privatization. That could create an opportunity for us over time.

The Trump administration has mentioned public-private partnerships for its infrastructure plans, but it's made "America First" a major theme. Could that limit the opportunity for you?

It is far too early to tell how Trump's statement on infrastructure will translate to spending. More broadly, good public-private partnerships often come from strong consultation between governments and the private sector. Canada has been following a model similar to the one Australia pursued, setting up an Infrastructure Bank to develop such relationships between public and private.

Australia accounts for about 15% of your portfolio. What do you like there?

Australia has been a global leader in asset recycling -- selling projects that need improvement and funding new projects. We think that model works very well, which is why Australia has been and remains an attractive market.

How has the infrastructure market evolved over the past decade?

The range of opportunities has increased. As governments have seen demand for infrastructure assets grow, they have been more open to structuring projects on a public-private basis, as well as privatization. And some companies with assets that would be attractive for infrastructure investors, have carved them out. We saw that clearly in the U.K., when National Grid [ticker: NGG] sold part of its gas-distribution networks.

Are there enough projects to go around?

Low interest rates have driven investors looking for yield to infrastructure, which has resulted in increased inflows and greater competition. But despite more [demand], the ways to invest are not particularly obvious. It's challenging to set up a direct investing program from scratch, and large funds tend to invest slowly. But it's certainly having some impact on the pricing of assets.

Toll roads are your biggest holding, accounting for 38% of the portfolio. What makes them attractive?

Toll roads are a very good example of a capital-intensive asset. A lot of money is spent to provide it, and over time people are prepared to pay for it, effectively generating a rent on the asset. Some people think of toll roads like real estate because they are not that complicated to operate, like a port or a utility company. For our Chicago Skyway investment, we analyzed the economy behind the region around Chicago to form a view on traffic volume. Over time, we believe people in the area will be willing to pay different prices based on level of congestion. That's just a dynamic of increasing car usage, population growth and growth of trade.

What makes a project attractive?

It has to start with a clear market position. My private equity heritage comes through in how I think of management. We firmly believe governance should come through boards, so we are active board members. We like to back strong management teams. We have seen a number of teams that are sophisticated in how they improve operations, taking out costs to be as efficient as possible. We work closely with our management teams to share those best practices across our portfolio of investments.

How do Trump's plans to build a wall and rethink trade pacts affect your Mexican investment?

We have invested in a toll road between regions in Mexico that will continue to industrialize. As car usage in Mexico grows and industrial traffic grows, we will benefit from that. Clearly, in any country there is going to be some risk. But we see that in Europe with Brexit, and potentially the U.S. It's complacent to say that geopolitical risk is limited to countries defined as emerging economies.

What impact will Brexit have on the 27% of the portfolio invested in the U.K?

To some degree, infrastructure assets have a national view since they tend to provide services to a specific region or within the country, so our U.K. assets will be more insulated.

India is desperately in need of infrastructure, but it has troubled investors with projects getting delayed or scuttled.

India has been an interesting journey. For toll roads, land requisition is quite challenging. It is sometimes climatically different to build in. Monsoons, for example, will put a lot of strain on roads, which can be washed away and have to be rebuilt. But if you look at global growth prospects, population growth, and the desperate under-provisioning of infrastructure and consider where infrastructure will be built over the next 25 to 30 years, it is very obvious to us. You have to focus on India and the largest emerging economies and countries related to them. We have to be aware of that and match our portfolios to that growth.

Thanks, Cressida.

Comments? E-mail us at editors@barrons.com

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February 25, 2017 06:01 ET (11:01 GMT)

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