Transcript April 2006 - Pension Funds and Urban Revitalization

Institutional investing in infrastructure: the changing
relationship of infrastructure to urban structures
Dr. Morag Torrance
New Finance of America's Cities Research Symposium
December 10, 2007, Cambridge, MA
© 2007 Capital Partners
Disclaimer
© 2007
This presentation was made possible by a number of institutions and
organizations including the University of Oxford, Capital Partners Pty
Ltd, the Munk Center for International Studies at Trinity College at the
University of Toronto, the University of Amsterdam, ABP Investments in
Amsterdam, the British Economic and Social Research Council,
NUFFIC at the Dutch Ministry of Education, the Prins Bernhard Culture
Fund, and Foreign Affairs Canada. I am solely responsible for the
content of this presentation.
1
The summer of 2006
Various infrastructure assets changed owners.
• Thames Water, London (13m customers)
– Sold by German RWE and bought by a Macquarie led consortium for £8b
Canadian, Dutch and Australian pension funds
• BAA airports, 7 UK airports
– Former public company focus of bidding war between Ferrovial and Goldman
Sachs
Spanish operator wins and values BAA at £10.3b
Singapore GIC and Caisse de Depot de Quebec co-owners of airport
• Indiana Toll road (157 miles)
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– Spanish Cintra and Macquarie won the bid to operate the toll road for 75
years
Valued at US$3.85b
2
Overview
• Infrastructure as a financial product?
• Why infrastructure as a financial product?
• Who is investing and how?
• The financialization of the urban infrastructure landscape
• Infrastructure’s changing relationship to urban structures
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• Conclusions
3
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Despite the reasoning that the state has social and political
accountability for the urban landscape so it can secure equal
access and, that due to the fixity of and the often large-scale
lumpiness of roads or water networks it is more efficient to
delegate the duty to the state, the ownership of and responsibility
for infrastructure is changing (Clark, 2005).
4
Infrastructure as a financial product?
“Infrastructure” is defined through the returns, not the
physical characteristics of the asset.
• Defined through the type of returns:
– Stable cash flows that are linked to inflation and economic growth over a long
period of time.
– Cash flows through user fees such as toll revenue and landing charges.
• Infrastructure assets have:
– low risks,
– low returns,
– and relatively low volatility due to the natural monopoly characteristic.
The consumer demand for the services is typically price inelastic.
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• Urban areas very attractive due to high barriers to entry.
5
Why infrastructure investing?
“Infrastructure” returns fit ALM and portfolio
diversification trends.
• Long-term stable returns a key strategy to match future plan beneficiaries’
retirement claims.
• Infrastructure offers the opportunity to diversify the total asset allocation.
• There is a range in the infrastructure returns that can be directly correlated to
the range in types of assets and their inherent risks.
– Toll roads have low risks and lower returns,
– Airports more risk and return,
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– While power generation is almost as risky as an average stock.
6
Why infrastructure investing? Cont.
Adding alternatives to the portfolio is a less risky way of
raising returns than accepting more market risk.
Expected Return
Private Equity
Average Equity
Property
Infrastructure
Risk
free/
Bond
Timber
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Risk (beta)
7
Who is investing and how?
Some of the largest pension funds in the world have
begun allocating to infrastructure.
• Australian first to invest in infrastructure, Canadians followed shortly.
• Two methods to invest:
– In-house teams (Canadians)
– Fund investing (with co-investment opportunities)
• Between 1-3% of assets under management allocated to infrastructure, some of
largest funds of over $200b looking to commit US$5b.
– Some Canadian funds have allocated up to 15% (of C$50b)
• Benchmark of 4% plus CPI often used as industry norm
– Historical returns of 10-35%
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– Expected returns in equilibrium around 6-9%
8
Who is investing and how?
Some of the largest pension funds in the world have
begun allocating to infrastructure.
• Recently interest in the USA is growing. USA slow to consider infrastructure.
• Largest investments banks developing infrastructure funds.
– Over 40 funds globally started in last 18 months, US$140b in equity
committed, not yet invested
– US$140b in equity can close up to US$1.1t in deals through gearing. US$30t
in projects worldwide available:
Mature operating assets
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Greenfields in emerging markets, including water and electricity networks
9
Who is investing and how?
Global consortia bid on assets around the world.
Institutional
Investor
Netherlands
Institutional
Investor
Canada
Institutional
Investor
Australia
Institutional
Investor
Singapore
Institutional
Investor
Canada
Specialist Infrastructure Fund
(Investment bank or manager)
Equity
contribution
Equity
contribution
Infrastructure
fund
(indirect)
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Toll road
USA
Contractor
/ Engineer
Operator
Water network
UK
Legal/Tax
Electricity network
Australia
Banks
(debt)
Institutional
Investor
(direct)
Airport
Denmark
10
Pricing of the urban landscape
Financial and legal instruments that capture the value of
a place while distributing the risk of it around the globe.
• Infrastructure assets valued through the WACC DCF method:
– Determining the NPV of the cash flows by forecasting the future cash flows
adjusted for appropriate risks and discounted at the weighted average cost of
capital.
• The governance of an urban infrastructure project is based increasingly on
rational financial models and formal legal structures:
– Global equity owners
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– Local public regulators
11
Financialization of the urban landscape
The scope of financial markets and institutions is
expanding to include urban infrastructures.
• Stock markets, financial centres, financial institutions and advisers, financial
regulatory bodies and rating agencies now continuously asses parts of the
urban landscape previously outside their scope.
• The pricing of the urban landscape is based fundamentally on risk and return
criteria.
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• Global financial institutions own and manage infrastructure assets in various
countries in one fund or portfolio.
12
Changing relationship to urban structures
A glocal form of supranational governance.
• Private market institutions are increasingly involved in setting of global
standards.
• International interlinking of infrastructure assets in global investment funds due
to the restructuring of socio-spatial relations in cities.
• The relationships among local governments and global investors, operators and
contractors are defined by contract, with emphasis on the notion of penalties
and performance incentives.
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• The urban is becoming part and parcel of supranational spheres that can be
priced, bought, traded, hedged, and governed globally.
13
Key messages
Conclusions
Infrastructure as an asset class will expand rapidly. Pension
funds can invest in their communities and predictable, low
risk returns match liabilities.
Billions raised and waiting to invest. Overpricing in the short
term as ‘hot’ asset class but returns in equilibrium good for
portfolio diversification.
New forms of urban and glocal governance are developing,
whereby legal requirements and financial plans drive the
governing.
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Any understanding of the likely topography of urban
infrastructure development over the coming decades must
begin with the financial industry.