Mea culpa. Yet another column not directly focused on the topic for this edition. How about this: agriculture is all about sowing and reaping, reaping and sowing, just like pension funds, which are like very long-term grain silos. There are opportunities to use that grain in the interim, before the farmer needs it back to take to market, for very productive purposes. And so we turn to pension funds and infrastructure. The U.K. government announced in November 2011 its intention to mobilize £20 billion from pension funds to finance infrastructure. This was followed by an MOU with the National Association of Pension Funds in the U.K. But of course the devil is in the detail.
Money is deposited in pension funds to be paid back gradually, giving these funds enviable access to long-term, patient capital. Funds need to optimize their investment portfolio across a broad range of assets, of different duration and levels of risk, to make a solid return and be ready to pay out as and when people retire. In most countries, pension funds have few investment options outside of government bonds at the longer end of the spectrum—alongside more risky equity and real estate investments.
This makes a marriage between pension funds and infrastructure sensible on many levels. Longterm opportunities for pension funds plus long-term capital for infrastructure projects equals economic growth for the country. Given the generous size of many pension funds, even a few percentage points of the portfolios allocated to infrastructure could make a significant impact.
There are a number of different opportunities for pension funds in the infrastructure space. Some are already active, in equity and debt for utilities and companies that focus on infrastructure, operation, equity, and refinancing of debt for existing assets (for example, operational PPP projects) with proven demand and revenue. However, the U.K.’s announcement implies new construction and new assets. This is a more challenging prospect for pension funds.
Retirements at risk?
Who among us wants our comfortable retirement on the golf course or the beach (or just not in line at the soup kitchen) dependent on whether the government gets its infrastructure strategy right? Or whether these PPP projects are as robust as we had hoped?
Pension funds should be managed with caution—even more cautiously than banks manage money—and the government should not confuse funding pensions with political priorities.
The irony of the U.K.’s approach is that this government has been particularly critical of PPP, dragging the Treasury through a painful process of defending its work. Of course, good will come of the criticism, as iron sharpens iron, and Treasury is being pushed to further improve the PFI program. But if government is serious about using pension funds to support infrastructure, it will need to create a safe environment for pension funds, and PPP will assume an even more critical role.
In addition to the deal offered to private investors under PFI (roundly criticized by the government as being too generous), pension funds may need additional comfort. They may even need guarantees to move them to invest, such as the certainty that their infrastructure investments will never yield less than an investment in government bonds would. (Rumors suggest that the sole incentive to be offered by the government to pension funds is a reduced management fee for infrastructure investments, though it is hard to see how pension funds can act without a bit more enticement.)
So how will the U.K. provide this extra something to protect the pension funds? Treasury was to announce more details of its plan as this column was going to press.
One size doesn’t fit all
The U.K. is not alone in facing this challenge. Governments have been trying to match pension funds with infrastructure for some time. But infrastructure debt is a complex investment, reserved for the most sophisticated of investors, and few of the pension funds have the in-house capacity to drive credit assessment of a PPP project, much less arrange PPP debt. Also, prudential rules make it difficult to invest in greenfields, or even most existing assets, without credit enhancement. The monoline insurers—traditional providers of credit wraps that would take some of the key risk out of such investments—have fallen away, with only limited signs of re-emergence.
Some governments, like Brazil and Russia, mandate big banks (Brazilian Development Bank and Vnesheconombank respectively) to allocate pension fund resources directly or indirectly, in the manner believed most expedient. Others create financial intermediaries to provide credit support to infrastructure to protect or attract pension funds, like the India Infrastructure Finance Company Limited or the Indonesia Infrastructure Finance Facility. Some use legal mechanisms and political encouragement, like certificados de capital de desarrollo in Mexico. In others, the government provides comfort letters, funding, and other support to bring in pension funds. The new infrastructure debt funds in India are good examples of this.
Each approach has its shortcomings. The arranged marriage between pension funds and PPP, though perfect on paper, is difficult to do well in practice. As Ben Franklin advised, “Keep your eyes wide open before marriage, and half-shut afterwards.” But do we have that luxury?