Investing in Infrastructure

1. Investing in Infrastructure Texas Senate Committee on Transportation and Homeland Security JULY 22, 2008 Pension Consulting Alliance, Inc.

2. Infrastructure Sectors What is Infrastructure? • Physical structures, facilities and networks which provide essential services within a community • Services provided are crucial to the economic productivity of a community • Assets are either privately owned or owned/operated by government entities

3. Infrastructure Investment Activity History of Infrastructure • Investment activity started in Australia in the 1990s when local governments had severe financial problems • In 1992, new laws were enacted which required workers to earmark funds for retirement savings • Formation of superannuation funds (pension plans) • Superannuation funds, armed with capital, needed creative investments to meet pension plan liabilities • Firms like Macquarie partnered with government entities to start investing in transportation infrastructure • In the late 1990s, Canadian pension plans became very active in infrastructure investments • Today funds like OMERS (Borealis), Ontario Teachers and Caisse de Depot are active global infrastructure investors

4. Infrastructure Investment Activity • Pension plan investors are embracing infrastructure investments and continue to research the sector

5. Key Characteristics Why Invest in Infrastructure? • Infrastructure is a unique asset class that offers investors a diversified source of stable, inflation-linked returns • Long Life Assets – Capital intensive assets with 25 to 99 year concessions, match for liability duration • Inflation Protection – Revenues typically linked to CPI • Monopoly or Quasi Monopoly – High barriers to entry due to scale and capital cost • Steady and Predictable Cash Flow – Produce strong and predictable yields • Low Correlation – Provides portfolio diversification, low beta • Inelastic Demand – Predictable demand with little volatility, less susceptibility to economic downturns • Limited Commodity Risk – Not subject to commodity pricing • Insensitive to Changes in Technology – Low risk of redundancy or technology obsolescence

6. Infrastructure Opportunity Demand for Infrastructure • The assessed condition and capacity of public works for the U.S. was graded a “D” for its overall infrastructure conditions Source: American Society of Civil Engineers

7. North America US$74.8B2 Global US$446.9B2 Infrastructure Activity • Total global infrastructure expenditure requirements estimated at 2.5% of GDP or $53 trillion through 20301 • Recent infrastructure deals closed by industry • Source: OECD. “Infrastructure to 2030: Mapping Policy for Electricity, Water, and Transport. Estimate increases to 3.5% of world GDP with the inclusion of electricity generation and other energy related infrastructure. • Source: Infrastructure Journal. Data represents activity during last 36-months as of November 2007.

8. Types of Infrastructure Structures Private vs. Public-Private Partnerships • Private Transactions – Majority of infrastructure transactions within the U.S. (energy companies, utilities, communication companies, etc.) • Public-Private Partnerships (PPPs) • Different structures and models • All models can be used for both brownfield (existing) and greenfield (new) assets Build Own Operate Transfer Build Lease Transfer Build Transfer Operate Build Operate Transfer Build Own Operate Build Transfer Public Responsibility Private Responsibility Lease Concession Divestiture Existing Services and Facilities

9. Infrastructure Opportunity Public-Private Partnership versus Issuing Public Debt • $1.6 trillion required on infrastructure projects over the next 5 years in the U.S. • Governments facing budgetary constraints looking for new ways to address infrastructure spending shortfalls • Infrastructure spending as a % of GDP has declined by 1/3 over last 40 years • Issuing an abundance of debt will influence cost and credit ratings of both new and existing debt instruments • Ability to use cash proceeds from PPPs to address immediate public issues while maintaining ownership of assets • Healthcare, education, housing, etc. • Ability to generate jobs with projects and improve operations • Govts should look to address infrastructure creatively to develop the appropriate structure and process for each state Source: Carlyle Group/American Society of Civil Engineers, Views and Estimates of the US Congressional Committee on Transportation and Infrastructure for 2005

10. Infrastructure Performance • Infrastructure offers attractive returns with lower risks Illustrative Investment Performance Source: JPMorgan Asset Management

11. Infrastructure Risks • Potential Institutional Investor/Pension Plan Concerns

12. Infrastructure Risks Things That Can Go Wrong • Trans-Texas Corridor • Political Risk - The Texas House of Representatives imposed a 2 year moratorium on privatization of transportation assets. • Chicago Skyway • Labor Risk - Toll road employees chose not to work for the new private management team and the City of Chicago had to absorb all toll road employees. • Black Warrior Parkway Toll Bridge • Headline Risk - Alinda project in Alabama is being highly protested due to a $0.50 increase in tolls. • Detroit Windsor Tunnel • Regulatory Risk - Tunnel opened in early 2001 as a short-cut to Canada. After 9/11 traffic moved slowly due to increased homeland security measures. • Atlanta Water Privatization • Partnership Risk - Concession agreement for the privatization of water was terminated when certain performance measurements were not met.

13. Infrastructure Investing Pension Plan Benefits of Infrastructure • High stable yields • Low correlation • Duration hedging • Inflation protection • Low cyclicality • Risk transfer • Low volatility Attractive risk adjusted returns Low beta relative to traditional asset classes Portfolio diversification Long lived assets to match liability duration 25 to 99 year cash flows Regulation or concession within pricing Inelastic demand and monopolistic position supports stable cash flows Via partnership arrangements risks transferred to subcontractors or back to public entity Limited exposure to economic downturns

14. Management Selection Structure PortfolioConstruction Strategy Infrastructure Investing Next Steps for Investing in Infrastructure • Sector definition • Risk tolerance • Investment criteria • Greenfield vs. Brownfield • Routes to market • Experience • Track record • Team size • Market presence • Partnership relationships • Deal flow • Fees • Internal structure and team • Allocation

15. PCA Recommendations Infrastructure as an Emerging Asset Class • PCA believes the focus on infrastructure is important as the needs within the US have been overlooked for decades • Compelling risk and return characteristics support infrastructure as a component of a real return or new asset class • Portfolio diversification and return enhancement • Opportunity to generate competitive risk adjusted returns relative to other asset classes with less dependence on asset appreciation • Low correlation to traditional asset classes • Given market inefficiencies and a plethora of new players next steps should be taken cautiously • Fund management selection is crucial • Transaction risks need to be properly researched and priced • Infrastructure criteria to be developed (definition, benchmarks, risk tolerance, strategy, portfolio construction, fees, etc.) • Governments should look into the various infrastructure structures that have been utilized to develop the structure that best meets their goals • Be cautious, take your time and do your homework!