May 4, 2021

How Pension Plans Are Investing Lucratively in Toll Roads

The cash flow is solid, except for occasional problems like pandemic-reduced traffic volumes.

Reported by Larry Light

Art by Pete Ryan

Is investing in toll-charging highways a road to riches? Well, most of the time, it’s pretty darn close. For pension plans and other institutional investors, the prospect of reaping a chunk of the toll take is a nice, often steady, complement to today’s low-paying bonds and volatile stocks.

“Toll roads produce a stable cash yield,” said Farouki Majeed, CIO of the Ohio School Employees Retirement System (SERS). Like many pension plans, his fund gets its exposure to road tolls through investing in a pool of kindred institutions, broadly dedicated to infrastructure in general.

In Majeed’s case, that means the Melbourne-based IFM Global Infrastructure Fund, which manages $52 billion worth of physical assets worldwide—and pays around 10% yearly. To be sure, the toll road investing model is not foolproof: Witness the bankruptcy filing of the Indiana Toll Road’s private operator a few years ago.

But there’s a reason that the returns from toll roads often are generous, typically in the low- to mid-teens. Historically, vehicle travel has increased with the growth of the population and gross domestic product (GDP), thus assuring a growing toll income. The investment “usually tracks the economy,” said Ellen Elberfeld, a senior analyst at Duff & Phelps Investment Management.

A state, city, or other public entity retains ownership of the road, and an assemblage of private investors, called a concession, has an experienced general partner (GP) on hand to run it. The GPs of these concessions, aka public-private partnerships or P3s, regularly pitch institutions on making infra allocations. The investors are limited partners who cream off a big dollop of the toll receipts.

Another enticement for toll road investors: the ability to raise what they charge motorists at the booth, which the public authority owning the road usually oversees, albeit in consultation with the private investors. What’s in it for the public owner? A fresh source of capital that it doesn’t have to tap taxpayers for.

The most common arrangement is for a state or city to get a lump-sum, upfront payment from the P3, although some entities (notably Texas and Virginia) also receive an ongoing cut of the toll revenue.

Road partnerships usually run smoothly, yet they have had rocky spells upon occasion, such as the jolt a year ago when commercial and private vehicle trips took a dive amid the pandemic lockdowns. For a time last spring, traffic plunged 40% to 75%, according to a tally by S&P Global Ratings. “You do face traffic volume risk,” said Clayton Camper, a real estate and real assets analyst with the New Mexico State Investment Council, the state’s sovereign wealth fund.

Traffic is rising again, however, and now is just 12% below the pre-pandemic level, federal statistics show. And maybe President Joe Biden’s infrastructure program could help, Majeed said, if public-private partnerships have a role. As part of the White House’s $2.3 trillion infra proposal, $115 billion would go to construct and repair roads and bridges.

Taking a Toll

The prospect of normally steady, low double-digit income streams have gotten toll roads a lot of attention from institutional investors in recent years. The California Public Employees’ Retirement System (CalPERS) in 2016 bought a 10% portion of the Indiana Toll Road, known as “the Main Street of the Midwest,” linking Chicago with the Ohio Turnpike. Caisse de dépôt et placement du Québec (CDPQ) last month purchased a 15% stake in the Indiana highway.

Meanwhile, in December, Australian toll road operator Transurban announced it was selling half its interest in 63 miles of highway in Northern Virginia for $2.1 billion, to two pension funds from Down Under and one from Canada: AustralianSuper, UniSuper, and the Canada Pension Plan Investment Board (CPPIB).

Many institutions aren’t investing in toll road pure plays, but rather in broad partnerships that cover many types of infra. For instance, the New Mexico State Investment Council invests in institutional fund offerings to gain exposure to toll road assets through diversified infrastructure funds, like those offered by Brookfield Infrastructure Partners. To get an idea of how such funds are divvied up, look at the Brookfield entity’s publicly traded stock, which derives a tenth of its earnings from toll highways, with the rest coming from the likes of seaports, airports, pipelines, and railroads.

The Toronto-based infra management company (30% owned by Brookfield Asset Management) routinely reaps returns in the mid-teens. Brookfield’s toll roads are mainly in South America, with a few in India. Its Chilean operation reported a 16% return last year.

Among pension funds, Canadian plans have been the most active investing in infra P3s. At Canada’s Ontario Municipal Employees Retirement System (OMERS), the commitment to infrastructure is 20% of its portfolio. For comparison, CalPERS has about 1% dedicated to infra, per its financial filing for the most recent fiscal year. The New Mexico sovereign wealth fund is around 3%, and the same for the Ohio school pension program.

The Canadian plans invest both close to home and overseas. CPPIB acquired majority control of the Toronto-area Highway 407 ETR concession company. The fund also partnered with Allianz Capital to purchase nine toll road concessions in India. The Ontario Teachers’ Pension Plan (OTPP) joined with CPPIB on two Mexican highways.

Sometimes, these pension investments draw a lot of scorn from public employee unions, which loudly object to their pension funds getting involved in private deals that supposedly displace civil servants. CalPERS took it heavy from a major union when it plunked money into the Indiana road.

For now, though, the success of that investment has muted the outcry. “CalPERS is no longer being criticized for the 12.7% return on its infrastructure portfolio,” wrote scholar Robert W. Poole Jr., a fellow at the Reason Foundation, in a study last year of private investing in toll roads.

Highway to Hell

Of course, as the virus-induced traffic volume problems show, things can go wrong. Consider the Indiana Toll Road’s original investing consortium: It was a joint venture between two publicly traded multinationals, Australia’s Macquarie Group and Spain’s Cintra, and it didn’t involve limited partners. In 2006, the alliance paid the state $3.8 billion ($3.6 billion of it in debt) for a 75-year lease on the highway, which opened in 1956. The Indiana highway authority used the lump sum to pay for road improvements elsewhere.

Turned out the consortium had taken on too much debt. The Great Recession tanked toll receipts, making debt service harder. By 2011, the Australian-Spanish joint venture, evidently needing more capital, had ballooned the debt to $6 billion. In Chapter 11, part of the debt had been whittled down, but the two companies wanted out. (They couldn’t be reached for comment.)

Result: A new, institutional investor-backed group took over to shepherd the toll road venture out of bankruptcy: namely IFM, paying $5.7 billion for the privilege. Solidly financed IFM, backed by 30 Australian pension funds, could inject a lot of equity capital into the ailing toll road.

The new operator refinanced more of the remaining debt, with some issues now paying around 5% interest, versus the previous rates of up to 11%. In all, under IFM, the road refinanced $2.8 billion and repaid another $1 billion in debt. But the large traffic falloff from the pandemic complicated its financial picture.

According to Fitch Ratings, outstanding debt now stands at $3.5 billion. The ratings agency thinks that is still too high, but is encouraged by the projections for increased traffic and toll revenue once the coronavirus recedes. The addition of CDPQ should help.

Tales of the Open Road

The idea of a toll road was hatched in Britain in 1707, when Parliament approved the concept, scholar Poole recounted in his study. The roads were privately owned. Tollways came to the US in 1792, when Pennsylvania chartered a company to build and operate a road between Philadelphia and Lancaster, known as a turnpike. (That name comes from a long bar blocking the thoroughfare entrance to horses and carriages, which swung aside once the toll got paid.) The first tolled US automotive superhighway, the Pennsylvania Turnpike, joining Philly and Pittsburgh, opened in 1940, run by a state agency.

In the early 2000s, France was the first to sell highway operating rights to private investment groups, according to Poole’s report. While public ownership of various functions is widespread in Europe, the idea caught on there as a way to ease the high tax burden on its citizens. The first such P3 toll operations were the A86 tunnel beneath Versailles and the Millau Viaduct in southern France. The setup caught on throughout Europe, then spread to Australia, Asia, and Latin America.

In the US since the 20th century, government-run tolled superhighways like the Pennsylvania Turnpike have been the rule. P3 versions began to crop up a couple of decades ago, yet they are not been as plentiful as they are overseas. Virginia started in the late 1990s with the $2.3 billion I-495 Express Lanes project, outside Washington D.C., built with both state and private money. Since then, other such construction endeavors took place in several other states (only two involved no state funding). Thus far, nine states in all, ranging from California to North Carolina, have used this model to build 17 roads.

P3 consortiums also operate six existing roads, with lease terms that last from 40 years to 99. The best known are the Chicago Skyway and the Indiana Toll Road, and one each in Colorado and Virginia, plus two in Puerto Rico.

As a growing economy is a P3 toll road investors’ delight, the outlook for this type of asset shows promise ahead. Growth might not be as rapid in the US, yet plenty of opportunities for investors are found abroad.

“You look at the traffic level, you look at how the tolls are set, you look at the type of road it is,” Duff & Phelps’ Elberfeld said. With such due diligence in hand, the trip could well be pleasant.