The recent Trans Mountain pipeline transaction has highlighted the often polarizing discussion around infrastructure projects, raising questions such as who should own them, how much they should cost and how to balance various competing interests.
Infrastructure is often defined as permanent assets a society requires to facilitate the orderly operation of an economy. They tend to be monopolistic in nature, provide an essential service and involve a long-term contract or concession. Examples of infrastructure assets include roads, water treatment plants, airports, energy and water transmission and distribution, communication towers, hospitals and courthouses.
Read: Should pension plans invest in the Trans Mountain pipeline expansion?
Historically, governments created and maintained infrastructure assets. But with budgetary constraints, in part due to rising health-care costs, they’ve tapped private capital to purchase and/or finance such assets. Due to their critical nature, some infrastructure assets will always remain in government ownership and control. An example is air-traffic control systems. Also, some infrastructure assets don’t generate revenue and, as a result, wouldn’t attract third-party money.
While private capital has had a role in creating, operating and purchasing infrastructure assets for years, it was only in the 2000s that the investment industry really took notice and began creating funds specifically formed to invest in the area. Last year alone saw the completion of more than US$900 billion in infrastructure deals, according to Preqin Ltd. Third-party managers are managing more than US$400 billion in infrastructure assets, with more than US$150 billion in so-called dry powder — capital raised but not yet invested — available. It’s clear that infrastructure as an asset class is maturing and finding its way into pension fund, endowment and foundation investment portfolios.
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With so much money raised and increased market participation by both managers and investors, one concern is whether assets have become too expensive. The return for core, developed, operating unlevered infrastructure assets has come down significantly to often less than six per cent today from more than 10 per cent years ago. Last year saw more than more than US$65 billion in aggregate capital raised. Of that amount, only US$11.5 billion was in core funds. Two-thirds of the capital was for core-plus and value-added strategies, which require operational expertise and often come with a price that reflects the additional complexity. Net returns for those assets range from eight per cent to 15 per cent.
In its fund manager outlook, Preqin surveyed more than 60 infrastructure fund managers to find out the key challenges they’re facing in 2018. Fifty-nine per cent cited valuations as the top challenge, while 36 per cent pointed to regulation and 33 per cent referred to deal flow.
Renewable energy continues to be a key source of deal flow for many managers, with 51 per cent of the infrastructure deals completed in 2017 falling in that category. That’s up significantly from 2016. Secondary deals are becoming more common, increasing to more than US$1.7 trillion in 2017 from an estimated US$245 billion in 2008. Included in the figures is the September 2017 deal that saw more than $9.7 billion paid by Pembina Pipeline Corp. for Veresen Inc.’s pipeline and midstream assets. While the deal has closed, the Competition Bureau continues to scrutinize it.
Read: 2017 Top 40 Money Managers Report: A look at the Canada Infrastructure Bank
Ignoring the competing environmental positions on the Trans Mountain pipeline transaction, from a pure financial perspective, the $4.5-billion purchase price and estimated project cost of $7.4 billion seem to be consistent with deal size in the infrastructure space. It will be interesting to see where potential investors come from — including, possibly, from Canadian pension funds, the Canada Infrastructure Bank and foreign investors — and whether national interest plays into the ultimate investor selection.