State Pension Poised to Make First Investment in Infrastructure

Proposal would take an up to $125 million stake in fund managed by Stonepeak Infrastructure Partners

For more than a decade, managers of New Jersey’s public-employee pension funds have been using so-called alternative investments like private equity and real estate to diversify and protect against major swings in the stock market. Now they’re on the verge of investing for the first time in infrastructure projects.

State pension officials say they are working to finalize the purchase of an up to $125 million stake in a fund managed by Stonepeak Infrastructure Partners, a firm that specializes in making profitable investments in infrastructure projects throughout North America, including renewable energy and water systems.

The proposed investment in the infrastructure fund was outlined during a recent New Jersey State Investment Council meeting, and it comes as pension system officials have been scaling back stakes in hedge funds, another class of alternative investments, amid concerns about high fees that many of those funds charge public-pension systems like New Jersey’s. It also comes as pension managers have been encouraged in recent years to consider taking on more socially responsible investments, and as President Donald Trump has been talking for months about launching a major federal initiative to renew the nation’s deteriorating infrastructure.

Under consideration

But state pension officials say their decision to invest in the infrastructure sector is something that’s been under consideration for some time, with the stake in Stonepeak’s Infrastructure Fund III becoming the first to reach the finish line, due in part to favorable terms being offered and the fund managers’ prior record of success.

“This is just the first one that’s hit, and it makes sense both in terms of projected returns and in terms of diversification,” said Tom Byrne, chairman of the investment council, following the panel’s meeting in Trenton last week.

New Jersey’s $75 billion public-employee pension system took action to allow its fund managers to buy stakes in alternative investments in the early 2000s, in the wake of a major stock-market downturn that hit the pension system’s investments particularly hard. Putting assets in alternative investments serves to diversify the pension system to help shield it from fluctuations in the stock market, and the investments can also help to boost overall returns.

For example, a consultant’s report released last year determined that the alternative investments generated more than 9 percent returns net of all fees over the previous five years. Those returns bested the pension system’s overall 7.65 percent assumed rate of return for all of its investment strategies.

Recent criticism

But the pension system’s hedge-fund stakes have drawn criticism in recent years as their high fees — typically 2 percent for management and 20 percent of performance — particularly among public-worker union officials who’ve questioned whether the state could get better returns by pursuing other, less-costly risk-mitigation strategies. And last year, amid a push by union officials who serve on the investment council, the state began to scale back some hedge-fund stakes while also seeking better fee structures in any new investments.

As an infrastructure-investment fund, Stonepeak, which has offices in New York and Houston, is offering the state a discounted management fee of 1.375 percent, and a 15 percent performance fee, according to proposed terms that were outlined by state Division of Investment officials during last week’s investment council meeting. Officials from the DOI, the agency that manages the pension system’s investments on a daily basis, also highlighted the firm’s previous success investing in infrastructure projects, saying the co-founders have extensive experience in the sector, including working previously for Australia-based Macquarie Bank.

“The team has deep relationships across the North American infrastructure industry,” the DOI proposal said.

“As a result, they often get early access to deals, and an opportunity to engage and execute without significant market competition,” the proposal went on to say.

Stonepeak’s fund managers have targeted middle-market projects in the United States and Canada, including renewable energy, communications, transportation, and water utilities. Their Stonepeak Infrastructure Fund II generated a net 31.2 percent internal rate of return for investors, and their prior fund produced a net 14.3 percent internal rate of return, the DOI proposal said.

Byrne, the investment council leader, praised Stonepeak’s experience and track record while speaking to reporters after the panel’s recent meeting. If the state’s proposed stake in Stonepeak Infrastructure Fund III is ultimately finalized, it would be worth up to $125 million.

But Byrne also said he’s expecting the pension system will be making other investments in infrastructure funds in the future.

“They’ll be plenty of good investment opportunities and plenty of needs in the infrastructure space so I would expect and hope that more things on attractive terms will follow this,” Byrne said.

And while state government itself is ramping up infrastructure investments through last year’s eight-year, $16 billion renewal of the New Jersey Transportation Trust Fund, Byrne cautioned against thinking that infrastructure is limited to just transportation assets like roads and bridges. He cited a 2014 report that estimated New Jersey’s infrastructure investment needs a total of as much as $130 billion, counting things like neglected drinking-water and wastewater systems.

“There is a lot of variety within the infrastructure category,” he said.