© 2007 Capital Partners

Dr. Morag Torrance

New Finance of America's Cities Research Symposium

December 10, 2007, Cambridge, MA

Institutional investing in infrastructure: the changing relationship of infrastructure to urban structures

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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.

Disclaimer

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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)

– Spanish Cintra and Macquarie won the bid to operate the toll road for 75 years

Valued at US$3.85b

The summer of 2006

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• 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

• Conclusions

Overview

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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).

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“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.

• Urban areas very attractive due to high barriers to entry.

Infrastructure as a financial product?

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“Infrastructure” returns fit ALM and portfolio diversification trends.

Why infrastructure investing?

• 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,

– While power generation is almost as risky as an average stock.

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Adding alternatives to the portfolio is a less risky way of raising returns than accepting more market risk.

Why infrastructure investing? Cont.

Expected Return

Risk (beta)

Risk free/ Bond

Infrastructure

Timber

Property

Average Equity

Private Equity

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Some of the largest pension funds in the world have begun allocating to infrastructure.

Who is investing and how?

• 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%

– Expected returns in equilibrium around 6-9%

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Some of the largest pension funds in the world have begun allocating to infrastructure.

Who is investing and how?

• 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

Greenfields in emerging markets, including water and electricity networks

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Global consortia bid on assets around the world.

Institutional Investor

Institutional Institutional Investor

Institutional Investor

Specialist Infrastructure Fund(Investment bank or manager)

Contractor/

Operator Legal/Tax(debt)

Equity contribution

Equity contribution

Airport Water network

Institutional Investor(direct)(indirect)

Institutional

Electricity network

Institutional

Netherlands

Institutional InvestorCanada

Institutional

AustraliaCanada

Specialist Infrastructure Fund

Contractor/ Engineer

Banks

Equity contribution

Equity contribution

Toll roadUSA

Airport Denmark

Infrastructure

Institutional Investor

Singapore

Australia

fund

UK

Who is investing and how?

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Financial and legal instruments that capture the value of a place while distributing the risk of it around the globe.

Pricing of the urban landscape

• 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

– Local public regulators

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The scope of financial markets and institutions is expanding to include urban infrastructures.

Financialization of the urban landscape

• 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.

• Global financial institutions own and manage infrastructure assets in various countries in one fund or portfolio.

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A glocal form of supranational governance.

Changing relationship to urban structures

• 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.

• The urban is becoming part and parcel of supranational spheres that can be priced, bought, traded, hedged, and governed globally.

Conclusions

New forms of urban and glocal governance are developing, whereby legal requirements and financial plans drive the governing.

Infrastructure as an asset class will expand rapidly. Pension funds can invest in their communities and predictable, low risk returns match liabilities.

Key messages©

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Any understanding of the likely topography of urban infrastructure development over the coming decades must begin with the financial industry.

Billions raised and waiting to invest. Overpricing in the short term as ‘hot’ asset class but returns in equilibrium good for portfolio diversification.