Infrastructure investment: An alternative asset class goes mainstream

Pension funds' evolving investment needs are aligning with the opportunities provided by P3 infrastructure projects

As institutional investors, including pension funds, seek to place funds in diversified opportunities, there is growing interest in alternative asset classes.

Canada, with its successful model for promoting investments in public infrastructure through public-private partnerships (P3), is particularly well-placed to provide for this growing demand.

Canada has been using and refining a P3 model for nearly three decades. Institutional investors across the country, notably pension funds, have increasingly invested in private market assets, including infrastructure.

P3 infrastructure investments offer potential long-term returns and diversification

The P3 model involves public authorities putting public infrastructure projects, like roads or schools, out for competitive tender. All parts of the project are covered by one agreement, so bidders must form into consortia of different team members required to complete the project.

Key insights

  • Canada's well-developed P3 model offers pension funds a ready and growing pool of infrastructure investment opportunities that may better match the funds' long-term liabilities
  • Infrastructure investment can provide a natural hedge against inflation, as well as sufficient ticket size to allow funds to deploy large volumes of cash
  • Investing in infrastructure does not have to be limited to domestic projects, however, any move into foreign markets must be accompanied by an in-depth understanding of the local situation and a robust service model

This structure allows for the selected private consortium to finance as well as design, deliver, operate and maintain the asset, in return for either a share of the revenue generated by its use or a stream of availability payments from the public authority - while the public authority retains ownership of the infrastructure.

Institutional investors, including insurers and pension funds, have come to appreciate the value of long-term investments in infrastructure as part of a general shift away from liquid and listed assets. Infrastructure, particularly for pension funds and other structurally long-term investors, has appeal as a natural hedge against inflation, as many of the returns generated from infrastructure assets, such as tolls or availability payments, adjust with inflation.

Expanding infrastructure investments

According to the Pension Investment Association of Canada (PIAC), infrastructure, private equity and real estate have significantly expanded their share of the Canadian pension fund investment mix since the financial crisis.

In 2017, for PIAC members, these categories collectively accounted for more than a quarter of all defined benefit pension plan investments, up from around 13 percent in 2006.1 Infrastructure's share of this figure has grown every year since 2006, when it accounted for 2.4 percent of the total, to 2017, when it accounted for 7.9 percent - exceeding the share of Canadian equities at 5.7 percent.

Institutional investors have come to appreciate the value of long-term investments in infrastructure

One particular attraction of infrastructure for pension fund investors in Canada and elsewhere is that projects typically require large amounts of long-term capital to be invested up front. Deploying cash in this manner provides an opportunity to mitigate risk associated with the low interest environment marked by compressed yields.

Keeping pace with demographic changes

As Canada expands it use of P3 to deliver more of the country's infrastructure requirements, the number of early-stage infrastructure investment opportunities is expected to grow. This will potentially enable pension funds to better match liabilities from an expanding demographic of retirees with reliable, cash-generating assets.At the same time, the assets they deliver will help to improve the competitiveness of Canadian industry, the economic prospects of future generations and quality of life.Infrastructure creates an economic or social value that ensures its performance over the lifetime of the investment while aligning with the stated purpose of the institutional investor and its beneficiaries.

Canada launches infrastructure bank

There is an expanding universe of P3 investments in infrastructure

There is an expanding universe of P3 investments in infrastructure, encouraged both by the current government's focus on accelerating infrastructure development and the creation of Canada's new Infrastructure Bank.

The Canada Infrastructure Bank, part of the government's Investing in Canada infrastructure plan, is investing CAD 35 billion of federal capital into infrastructure projects.This initial funding is designed to attract private sector and institutional investment to new revenue-generating infrastructure projects that are considered to be in the public interest, such as public transport, social and green infrastructure. The private investment and expertise that the bank's funding attracts should help public dollars go further.

The Infrastructure Bank model will continue to build on Canada's mature P3 market, which now accounts for more than a third of total infrastructure procurement. Access to bank funding will be available to provincial, territorial and indigenous government partners as well.

A globalizing market

There is also an increasing level of institutional awareness of infrastructure as an asset class around the world. This parallels the increasing need for renewing and upgrading infrastructure in many major developed economies as well as the unfulfilled requirements of economies everywhere.3 It is an asset class that is well-suited to the disciplines and diversified investment portfolios of Canada's institutional investors. To invest effectively over the long term, however, it is important for these institutions to continue to develop their global knowledge and a suitable service model for managing a diversified global infrastructure portfolio.

You may also like

Sources

  1. Pension Investment Association of Canada (2017) Asset Mix Report
  2. Infrastructure Canada (2018) Investing in Canada Plan
  3. Aon, The One Brief (March 3, 2016) Can P3 Fill The Infrastructure Gap?