CalPERS appears to be going from the frying pan into the fire. Having managed finally to exit hedge fund investments, years later than for their own good, but still well ahead of their peers, they’ve gone for another type of high-risk investment. One of the giant fund’s recent deals was an investment in a private toll road. CalPERS appears not to have gotten the memo that the privatization of roads and bridges predictably turn out to be turkeys.

As we’ll see below, CalPERS can argue that its investment is different from the typical toll-road money pit, in that it’s buying into a restructuring, not an original financing. But there’s every reason to think that CalPERS, as a newbie, does not know what it does not know. And as with private equity, it is up against players with vastly more sophistication that it has.

Here’s the outline of the CalPERS investment by Jon Ortiz the Sacramento Bee, which focused on the critique made by the state engineers’ union:

The retirement fund recently purchased 10 percent of Indiana Toll Road Concession Co. The firm runs a 157-mile stretch of highway that runs across northern Indiana from Illinois to Ohio. California’s state engineers’ union says it’s a horrible investment that sinks government employees’ money into a project that, ironically, is hostile to government employees. The toll-road company is the first of what fund managers anticipate will be more investments in infrastructure and transportation projects as the $291 billion system broadens its reach into those sectors. Indiana Gov. Mitch Daniels thought a public-private highway partnership would be a win-win for the state and the private sector when he proposed it in 2005. A year later, Indiana Toll Road Concession Co. won the contract with a bid that included $3.8 billion up front. The money was earmarked for highway construction and maintenance projects statewide. Meanwhile, the 75-year deal gave the firm responsibility to manage the state-owned road in exchange for keeping collected tolls. Then the recession hit. Traffic volumes fell. The company’s debt reportedly grew from $3.4 billion to $6 billion eight years later. It went bankrupt in 2014. (Indiana got to keep the up-front money.) IFM Investors bought the company for an undisclosed sum last year. Then last week CalPERS announced its stake, the fund’s first U.S. transportation purchase in a new program emphasizing infrastructure investments. CalPERS didn’t say how much it paid. The deal gives Professional Engineers in California Government a heaping helping of heartburn, however. The union has fought public-private partnerships for years. Handing over what should be government work to profit-driven firms invites cost-cutting for profit, the union says, which hurts projects’ quality and compromises safety. Such agreements also shift work from the public-sector servants to the private-sector mercenaries, PECG has said. The bulk of its 13,000 members are Caltrans employees. “Public-private partnerships are risky investments for anyone, but it is particularly troubling when you’re investing the hard-earned money of public employees,” said union spokesman Ryan Endean, noting that a Texas toll-road partnership recently failed. “CalPERS members would be better served by putting money in investments with a proven record of strong returns, not speculative deals like public-private partnerships.”

The CalPERS spokesman gave the industry patter on infrastructure deals, that they provide predictable returns with moderate long-term inflation protection.” Someone might clue her in that theory and practice are often two different things.

Now CalPERS may have bought into a distressed project at such a good price that everything will work out. But as a newbie investor in this field, the odds are against it being able to identify all the pitfalls and value them well. And CalPERS did not decide to invest via a fund; this is a direct deal with an Australian infrastructure manager (IFM is the seventh largest in the world)>

And the record of road and bridge privatizations is consistently lousy. From a 2014 article in Thinking Highways:

Beginning with the contracting stage, the evidence suggests toll operating public private partnerships are transportation shell companies for international financiers and contractors who blueprint future bankruptcies. Because Uncle Sam generally guarantees the bonds – by far the largest chunk of “private” money – if and when the private toll road or tunnel partner goes bankrupt, taxpayers are forced to pay off the bonds while absorbing all loans the state and federal governments gave the private shell company and any accumulated depreciation. Yet the shell company’s parent firms get to keep years of actual toll income, on top of millions in design-build cost overruns…. Of course, no executive comes forward and says, “We’re planning to go bankrupt,” but an analysis of the data is shocking. There do not appear to be any American private toll firms still in operation under the same management 15 years after construction closed. The original toll firms seem consistently to have gone bankrupt or “zeroed their assets” and walked away, leaving taxpayers a highway now needing repair and having to pay off the bonds and absorb the loans and the depreciation. The list of bankrupt firms is staggering, from Virginia’s Pocahontas Parkway to Presidio Parkway in San Francisco to Canada’s “Sea to Sky Highway” to Orange County’s Riverside Freeway to Detroit’s Windsor Tunnel to Brisbane, Australia’s Airport Link to South Carolina’s Connector 2000 to San Diego’s South Bay Expressway to Austin’s Cintra SH 130 to a couple dozen other toll facilities. We cannot find any American private toll companies, furthermore, meeting their pre-construction traffic projections. Even those shell companies not in bankruptcy court usually produce half the income they projected to bondholders and federal and state officials prior to construction.

And again, while CalPERS is not investing in a new deal but a restructuring of a deal gone bad, which was originally done by industry leader Macquarie Bank and is now in the hands of IFH Investors, another major Australian player and the seventh largest infrastructure firm in the world. The major player seek to emulate the Macquarie model, which entails pulling out tons of fees. CalPERS is escaping only one layer of fees by going direct, at the cost of diversification. From a November 2014 article, How Macquarie Makes Money by Losing Money on Toll Roads:

The Sydney Morning Herald’s Alan Kohler shares [hedge fund manager Jim] Chanos’ skepticism. In a 2004 editorial, he wrote, “The Macquarie model is justly famous around the world. It is quite possibly the most efficient method of legally relieving investors of their money ever conceived.”

On the one hand, CalPERS was wise to avoid investing in new construction, since those deals involve such huge information asymmetries, with both the contractors and infrastructure firm having aligned incentives in paying too much for the deal, that investors are taking undue risks. But on the corporate side, there is a long history of companies coming out of bankruptcy only to wind up back in it again in a few years. And the asset manager, as with the original deal, pulls out enough in fees so as to be indifferent to the outcome of any particular project. There’s not much history on these restructurings of infrastructurings, and CalPERS appears to be exhibiting overconfidence in venturing into an area where it has little experience.