Wednesday, June 13, 2007

"We do not want to participate in an asset bubble."

Investing in the Fast Lane

Toll Roads and the Like Draw Large Players; A Bubble in Turnpikes?


The Wall Street Journal
Copyright 2007

Pension funds think they have spotted the next big thing -- and it looks a lot like the Pennsylvania Turnpike.

The search for steady returns is prompting U.S. pension funds and other big institutional investors to put money into infrastructure businesses such as toll roads, ports, pipelines and utilities. Indiana and Texas are among the states that already have done deals with private investors, while Pennsylvania and New Jersey are considering it.

Infrastructure investments are relatively new to U.S. pension funds, although they are popular in countries like Australia, Canada and Britain. But it is catching on: Over the past year, Wall Street firms, including J.P. Morgan Chase & Co. and Goldman Sachs Group Inc., have raised billions of dollars to invest in the sector, much of it from pension funds.

They are following in the footsteps of companies like Australia's Macquarie Bank Ltd., which specializes in infrastructure funds. Macquarie estimates there is more than $38 billion in unlisted funds that are seeking to buy existing public and private infrastructure projects or build new ones world-wide.

Aging Infrastructure

One area of opportunity: the U.S., which is full of aging roads, airports and bridges. And local governments -- which traditionally relied on municipal bonds to finance projects -- are exploring other ways to raise cash, because many of them already have borrowed extensively. Moreover, the private sector is offering attractive prices.

The trend is stirring some controversy. On Monday, the governor of Texas signed a law instituting a two-year moratorium on private toll-road projects in the state, part of a backlash against a series of earlier transactions.

Some observers also worry that with so much cash chasing deals in the sector, the bidding process is pushing prices up to unreasonably high levels.

It can be expensive in other ways, too: In general, the infrastructure funds run by Wall Street firms make their money by taking a portion of profits and charging additional fees, much like hedge funds or private-equity investors. Since many of these infrastructure-investment funds are new, they don't have a track record to demonstrate their abilities to investors, said Michael Dudkowski, a consultant at Wilshire Associates who advises U.S. pension funds.

Considerable Appeal

Still, for pension funds, infrastructure holds considerable appeal. Pension funds are in a constant race to make sure the returns from their investments keep up with their future obligations to retirees. At the same time, they are reluctant to make risky bets, a lesson still fresh after the bursting of the stock-market bubble in 2000.

Infrastructure is touted as a source of a steady, if unspectacular, stream of income. It also is seen as a way to protect against inflation, because such projects often can raise their rates in line with price increases.

Pension funds say they expect their infrastructure investments to give them an annual return in the range of 8% to 10% and, in a few cases, higher.

'Stable Returns'

Infrastructure should deliver "fairly predictable, stable returns," said Steve Cochrane, who oversees $3.9 billion for the North Dakota state pension fund. Mr. Cochrane recently invested $100 million in an infrastructure fund set up by J.P. Morgan, which has bid on a Texas toll road and a Colorado gas-distribution business.

Macquarie Infrastructure Partners, a new, $4 billion fund targeting North American projects, received more than 80% of its funds from pension funds in the U.S. and elsewhere, said Christopher Leslie, its chief executive. Mr. Leslie said pension funds connected to unions in the construction trades were particularly enthusiastic, because they consider infrastructure investments to have the added benefit of creating jobs.

Macquarie helped start the infrastructure craze by tapping into Australia's pension funds, a strategy it has since taken global. In 2005, it paid $1.8 billion together with a partner for a long-term lease of the Chicago Skyway, a nearly eight-mile-long elevated expressway.

'Regulatory Risk'

So far, progress in the U.S. has been slow. "In this area, you have to think about political and regulatory risk," said Mark Weisdorf, who heads J.P. Morgan Asset Management's infrastructure investments group. Governments can change their minds about how and whether to proceed on deals with the private sector. Trucking groups also are mounting opposition to further road sales, because they usually involve higher tolls.

Another risk for would-be investors: Because the projects often are large and complex, there isn't a broad and deep market of prospective buyers, which could make them tough to sell.

Still, pension funds are deciding that some of these assets are worth the risk. The Illinois State Board of Investment, which manages $12 billion in pension money, last year decided to shift funds from bonds into infrastructure. With returns in the range of 5%, bonds were acting as a drag on the fund's overall targeted return of 8.5% a year, said William Atwood, its executive director.

Higher Returns?

As a result, the pension fund's board began looking for investments that acted like bonds but held the possibility of higher returns. It decided to allocate more than $600 million to infrastructure, equivalent to roughly 5% of its portfolio.

Mr. Atwood said many of the infrastructure funds operate like their private-equity counterparts, charging fees of as much as 2% of investments and 20% of profits, plus transaction fees. His expectation is infrastructure investments will provide an annual return of 9% to 10% from current cash flows.

The two largest pension funds in the U.S. -- the California Public Employees' Retirement System and the California State Teachers' Retirement System, which together manage more than $400 billion -- also are looking to include a small allocation to infrastructure in their portfolios. Formal approval for such investments is likely to come from the boards of both pension funds later this year.

Some investors worry there is too much money targeting the sector. Michael Nobrega, who heads a $37 billion pension fund for Ontario's municipal employees that submitted an expression of interest for the Pennsylvania Turnpike, said he is proceeding with caution. "We do not want to participate in an asset bubble," he said.

Write to Joanna Slater at

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