Infrastructure is also considered a defensive investment, since it is immune to changes in the economic cycle. This attribute may be all the more attractive to investors today, with global capital market volatility increasing considerably amid an unfolding global credit crisis. Infrastructure returns are weakly correlated with the returns of other major asset classes, which enhances the benefit of diversification. Infrastructure returns are also more strongly correlated with real or inflation-adjusted interest rates, since changes in toll rates or tariffs are often tied to the rate of inflation and, in regulated sectors, to changes in regulated returns.
Does it all seem too good to be true? Naturally, there are some risks to consider. Liquidity is a major issue: direct investing can tie up large pools of capital for long periods of time, with little or no secondary market available. When investing on a direct or partnership basis, human capital is a significant concern: having a team of dedicated, experienced people with a range of diverse skills is a must, since expertise in everything from investment banking to health and safety is required.
Leverage is another issue, since the attractively high rates of return in recent years were partly due to the use of leverage. Now leverage has suddenly become much less attractive, as risk aversion in credit markets has increased significantly.
Political and regulatory risks are also potential concerns. We often associate political risk with projects in more distant and fragile economies or locations, such as building an airport in Ecuador or a toll road in China. However, if there is a change in government or if the government in office has a change of heart, political and regulatory risk can also be an issue in North America.
Taking all of this into consideration, it’s still likely that interest in infrastructure investing will continue to grow among Canadian pension plan sponsors. Investors can gain exposure to this asset type through debt financing, publicly listed infrastructure funds, managed trusts and direct partnership—each option offering progressively greater risk, reward and control.
The trend toward investing in infrastructure is a global one. In Australia, for example, infrastructure has become a bona fide emerging asset class. Sources such as bfinance and the Macquarie Bank Group note that the average pension plan in Australia has a 5% allocation, and larger plans routinely have allocations of approximately 20%. Large pension plans in Canada are following suit, and we expect that innovative products will soon be developed to allow smaller and medium-sized pension plans to participate more actively.
The lure of long-term, stable cash flows, low risk of capital loss and potentially attractive riskadjusted rates of return is strong, but investing in infrastructure is not without its challenges. Fiduciaries should develop the necessary internal expertise or hire experienced external advisors to guide their activities. So the next time you travel from Vancouver to Whistler on the Sea-to-Sky Highway, consider the possibilities of the underlying investment opportunity as well.
Patricia Croft is vice-president and chief economist at Phillips, Hager & North Investment Management Ltd. pcroft@phn.com.
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