Ontario Teachers' Pension Plan is the largest single-profession pension fund in Canada, and currently holds assets with a net worth of C$106 billion ($100 billion). Its investments since 1990 have experienced an average annual rate of return of 11.8%, and cover a diverse number of sectors, notably infrastructure, utilities and telecoms.

Teachers' is an independent corporation, with 600 employees, which works with its sponsors, the Ontario government and the Ontario Teachers' Federation, to make investments for the pensions of the province's teachers. There are 271,000 teachers, both working and retired, currently involved in the plan.

Jim Leech was named as president and chief executive of Teachers' on 5 September 2007, taking over from Claude Lamoureux, who will retire later on 1 December. Lamoureux was the first CEO of the fund, which was formed in 1990 from the government-run Teachers' Superannuated Plan. In subsequent years, Teachers' morphed from a plan restricted to investing in non-marketable Provincial debentures (since its inception in 1917 to its remodelling in 1990), to taking responsibility for the investment of all its assets (as of 1990), to running its investments directly.

Leech is currently head of private equity at Teachers', after joining its private capital unit in 2001, and is responsible for C$16 billion of investments in private equity, venture capital, infrastructure and timber. He is characteristically low-key about his appointment, "I'll be taking over in the context of the organisation doing exceptionally well, and from its founder, so I'm currently in a listening mode".

In-house and unbound

Since Leech joined Teachers', it has stopped using outside fund managers such as Macquarie to deal with its investments, and since 2001 now handles all aspects of its investments internally. "Five years ago, there weren't that many funds, but now we are dealing with a more developed market", he notes.

Leech explains that it still has a number of residual investments outstanding, specifically stakes in Copenhagen, Bristol and Rome airports through Macquarie Airports, that it funnelled through a third party until it became comfortable with the market: "By 2001, we had the expertise to do it ourselves more cost effectively; we didn't want to give away the two and twenty [2% administration fee and 20% of any profit], when we could do it better, faster and more efficiently".

Leech divides the Teachers' investments that he oversees into two distinct categories, private equity and infrastructure deals, though there is some degree of overlap with the two.

The recent C$51.7 billion agreement to take over Bell Canada, in a joint venture with Providence Equity and Madison Dearborn, was, he said, a private equity deal. If it is approved, the Bell Canada acquisition will represent the largest corporate takeover in Canada's history. The acquisition of four container terminals from Orient Overseas earlier this year, on the other hand, he describes as an infrastructure financing despite the high leverage on the deal, and debt covenants much more common on leveraged buy-outs.

The Bell Canada deal is due to close in the first quarter of 2008, and is facing a shareholder vote on 21 September. The acquisition involves the C$34.8 billion purchase of BCE's outstanding shares and the assumption of its existing debt. Teachers' stake in Bell Canada will be 52%, with Providence Equity Partners holding 32%, Madison Dearborn taking 9%, and a remaining 7% to other investors. The Teachers' plan is to make Bell's wireless activities more competitive.

For Teachers' purposes, the risks of the private equity investments are counterbalanced by the longer-lived and more stable cashflows of the traditional infrastructure assets. The long life of the investment, and the low volatility in returns, offsets the liabilities of the more volatile private equity investments with shorter lifespans. "The infrastructure investments hedge the risks of the more highly levered deals," says Leech.

Steroids and heart attacks

He cites treasury inflation protection (TIP) bonds and real-rate bonds as the traditional perfect asset, with predictably consistent yields, but says that "infrastructure assets are like real rates on steroids". This liabilities hedge is fundamental to an investor such as Teachers', which needs to payout to beneficiaries at least 50 years hence. He continues, "the only similarities are, that the equity is not publicly traded, and the due diligence process is different".

Still, recent events in global credit markets have made both types of acquisition look very aggressive. Several commentators, not least among them the precociously bearish Standard & Poor's, have expressed concern at the multiples, financing structures, and refinancing risk attached to recent infrastructure buy-outs. Leech, at least with respect to infrastructure, is more confident. "The panic that has invaded the market will affect everything, but with infrastructure, though there may be some backing up in the availability of financing, it won't be much, because it is not so leverage-oriented".

However, despite the long maturities on the infrastructure investments, Libor has reached its highest level since 1998, clocking in at 6.8% in early September. The underlying rate will affect assets' debt service burdens no matter what the leverage and maturity. Nevertheless, Leech believes the long-life infrastructure assets can ride out the economic storm.

In fact, Leech suggests that it is other investors that might be blurring the boundaries. "My concern is that they [the funds/managers] may push the definition of infrastructure further along the risk spectrum. There is a grey zone where private equity goes down, and infrastructure risk goes up". By maintaining a definition of infrastructure as assets related to transport, Leech's simplified rule of thumb, deals are completed with project financings rather than the hybrid leveraged-project financings that have been emerging on recent deals.

In one distinction between Teachers' and its peers Leech is spot-on. Teachers' prefers to hold its assets in perpetuity; once an infrastructure asset is acquired, its revenue stream is expected to go out a minimum of 75 years. According to Leech, returns on the plan are not dependent on releveraging, and Teachers' does not need to extract hefty performance fees from its businesses. So while Leech views the Bell Canada buy as very much a private equity deal, he notes that telecoms deals are becoming increasingly like infrastructure project financings in how their debt is arranged.

Conversely, the opposite was said of Teachers' recent acquisition of four container terminals from Orient Overseas in April 2007. Many lenders and advisers familiar with the transaction considered it as a hybrid of project and leveraged financing. Teachers' paid $2.35 billion for the terminals in New York, New Jersey and two in Vancouver, a valuation believed to be roughly 22 times Ebitda. The $1.88 billion debt financing, arranged by RBS and RBC, represents leverage of 13.5x Ebitda. As the leverage reduces, the pricing also reduces, but it started at 140bp over Libor.

Though the pricing structure features particular traits of a leveraged financing, the assets have low risk, a solid revenue stream with strong growth prospects. Leech notes, "the Vancouver asset has a 70% monopoly in that port, and 80% of the beer entering the United States comes through the New Jersey terminal". Citing these factors, as well as the fact that the assets are expected to produce revenue over a long lifespan, Leech disputes that the deal was highly levered. Rather, he describes it as comfortably fitting into the infrastructure space.

International interludes

Teachers' is pursuing two water sanitation deals in Chile. The first of these closed on 27 August 2007. It involved the acquisition of 100% of Aguas Nuevo Sur Maule for an undisclosed sum, estimated to be around C$200 million, and buying a 50.8% controlling interest in Empresa de Servicios Sanitarios del Bio-Bio (ESSBIO) from the Southern Cross group for C$356.5 million ($340 million). Together, these utilities account for 20% of the regulated water and wasted services in the country.

The second of the deals is in negotiation, and involves the acquisition of 48.92% of Esval, which serves 13% of the country, from Consorcio Financiero for C$384 million ($365 million), with the intention to acquire the remaining shares shortly. The deal is conditional upon Teachers' acquiring at least 50.01%, since the Chilean government economic development agency, CORFO, holds 29% of the shares, and tender them if Teachers' reaches this threshold.

Teachers' worked with law firms Stikeman Elliott (Canadian) and Carey & Cía (Chilean) on both deals. Teachers' raised 65% of the purchase price for the purchases in the Chilean bond market, and funded the remaining 35% with equity. Dresdner Kleinwort advised on the deal, and managed the bonds, arranging private placements with Chilean institutions.

Leech explains that the water firms have "exclusive operating rights in their regions, and a monopoly of the market," and expects them to perform to Teachers' 75-year horizon. Teachers' is keen to invest in the Chilean market, and Leech highlights the country's economic and political stability. Leech also highlights the assets' inflation-linked returns.

Currency risks are diverse in Teachers' international investments. Leech explains, that it plots its deals in local currencies, and leaves the assets sitting in the native currency, rather than automatically hedging each exposure into Canadian dollars. The portfolio's foreign currency exposure is then assessed in aggregate, and Teachers' then goes out and arranges hedging, whether long or short, on a collective basis.

Though an infrastructure and transportation deal, Teachers' acquisition of a 48.25% stake in Birmingham airport in May 2007 did not involve a traditional project financing. It will acquire the stake for £420 million ($851 million), with 60/40 joint-venture partner Victorian Funds Management Corporation, through its Airports Investment Group (AGIL). Teachers' portion of the purchase price is 100% equity funded. It will buy the shares from Macquarie Airports and Aer Rianta (part of the Dublin Airport Authority), with the local council retaining a 49% stake in the airport, and an airport staff's trust holding the remaining 2.75%. The deal is due to close in October 2007.

Leech says the decision not to raise debt for the purchase of the shares is because the joint venture did not want to borrow against the operations of the assets, and increase the airport's debt load, when they would own less than half of it. Teachers' also owns 25% of Northumbrian water, a stake it bought from Suez in April 2005, and 25% of Scotia Gas, in partnership with Borealis (manager of Ontario Municipal Employees Retirement Systems' fund, 25%) and Scottish and Southern Energy. After completing the acquisition of the UK-based gas distributor in June 2005, the buyers refinanced it with a £2.2 billion wrapped securitization, a first for the asset type, in October that year.

Teachers' has turned itself into a disciplined principal investor, and is, after six years, still one of a very small number of funds making direct investments in the infrastructure markets. The recent sums that investment banks have succeeding in raising for funds suggests that outside managers are still the favoured conduits for institutional cash. But if Leech's portfolio survives the current instability, and his move into the top spot, other funds may yet follow suit.