A cautionary tale: Pension funds and the infrastructure bandwagon
Infrastructure finance has risen to the top of the international financial policy agenda. Within the new infrastructure finance agenda emerging in such forums, the $85 trillion that institutional investors, and in particular pension funds, are estimated to hold in savings, are seen as playing a starring role.
Pension fund investments in infrastructure are not in principle a bad idea, especially if the infrastructure it leads to creates growth, generates decent jobs and improves living standards. But asset owners would do well to ask a few questions before jumping in, writes Aldo Caliari, Director of the Rethinking Bretton Woods Project at the US-based Center of Concern.
One could see why pension funds could welcome this move. For over two decades, the collapse of publicly-financed retirement systems, characterized by privatization or precarization of social security systems and the growing ratio of ageing citizens to working citizens, left pension funds looking for alternative investment outlets that can help them respond to the demands of their beneficiaries. The depressed-interest rate environment of the last few years has only made this need more acute.
The new infrastructure agenda posits that increasing investment in infrastructure is a logical path for plugging the financial gap pension funds face. Meeting the estimated additional $1 trillion a year of infrastructure spending the developing world needs is also a way for infrastructure to invest long term and profitably, as its liability structure requires.
However, to ensure they benefit from the investment, workers whose retirement monies are at stake should keep a few things in mind.
First, pension funds should query what specific part of the infrastructure universe the assets in question target, as infrastructure projects lack the degree of homogeneity and standardization that would be required to speak of an ‘asset class.’ How far back there is historical data on performance of infrastructure in the sector and what portion of the returns may be due to leverage in the particular investment structure as opposed to returns on the infrastructure projects themselves.
Second, for assets that pension funds are expected to hold in the long term it is important to ensure they can withstand long term risks. Infrastructure projects typically require affecting large swathes of land and create large environmental footprints, as the World Bank President recently acknowledged. It would be important to have strong environmental and social safeguards. Likewise, it would help to evaluate whether institutional frameworks in the host countries ensure a fair risk- and benefit-sharing built in contracts since the beginning. This is more likely to happen in countries with adequate checks and balances and policies that guarantee transparency and a safe environment for public interest groups to debate and challenge features of the contracts that may distort the share of risk that falls on the public. An assumption that the State has unlimited ability to raise user fees and back up exorbitant guarantees for risks such as inflation or lack of minimum demand may hold in the short term, but is unlikely to do so in the 25 or 30 years that infrastructure concessions last.
Third, like in any other investment, the role of financial intermediaries needs to be carefully examined. The more intermediaries between the funds of asset owners and the final projects in which said funds are invested, the higher the chances that intermediary fees will tilt incentives towards the short term and pile on fees that the expected returns on the project have to pay.
Ideally, no intermediation between asset owners and projects would be the best case scenario. However, as novel and not-so-well known assets, assessment of infrastructure projects to invest on may prove quite complex and challenging for pension funds to do by themselves. In turning to intermediaries, though, they need to be aware of the ensuing opportunities for unscrupulous arbitrage between the true risk of projects and the perceived credit risk of the assets built upon them.
So, asset owners should be asking if the regulations intermediaries have to abide with offer good guidance on asset managers’ capacity and duty to act in line with asset owners’ objectives, duties to act in the interest of ultimate beneficiaries and owners, preventing conflicts of interest and on terms of asset managers’ contracts. Raising these questions would be in line with the demands the Trade Union Advisory Committee for the OECD made when commenting on the G20/OECD High-Level Principles of Long-Term Investment Financing by Institutional Investors.