Globally, pension and insurance funds have by many estimates more than $50 trillion under management. Some of the biggest with sizes well beyond $100 billion per fund.
With a large part of the global bond and equity markets in flux many pension funds are eager to allocate more of their funds to infrastructure and many are contemplating direct involvement.
To better understand this development we sat down with Dr. Georg Inderst, author of several reports on the sector for OECD, EIB and others, for a quick question and answer session.
Q: Why are pension funds and insurance funds investing in infrastructure?
A: Infrastructure has become particularly popular with pension funds because of the generic promise of stable, long-term, possibly inflation-linked cash flows. Other attractive characteristics often mentioned include a relatively low sensitivity to swings in the economy and markets and low correlation of returns with other asset classes. Increasingly important, it could even become an important element of socially responsible, sustainable, ESG or climate change investing. The expectations raised are in no way modest.
Q: How big a share are these funds putting into infrastructure?
A: Some Australian funds have pioneered into infrastructure already in the 1990s, and a number of bigger Canadian, Dutch and Nordic pension funds moved into infrastructure in the mid-2000s. The initial strategic allocations tend to be somewhere in the 2-5% area of total assets but there are more courageous examples. OMERS, CPP and OTPP in Canada are reported with figures of 15%, 9% and 8% respectively, the Dutch APG with 7%. This does, however, not mean that all this money is actually invested – that can take a bit longer for a variety of reasons.
Q: From your papers on the matter it would seem like these funds would like to place substantial more funds – compared to what they are investing today how much do you think they would want to further invest?
A: Interestingly, investor intention surveys had infrastructure as one of the most popular asset classes before, during and after the financial crisis. A recent survey of 1,350 institutional investors globally gave an average allocation of 4% and a target allocation of 5.3%. However, we should not forget that the majority of pension funds still do not have any exposure to specialist infrastructure funds, which means that globally, the overall institutional allocations is still only around 1%.
Q: Do you see a preference for going direct versus going through other funds with pension and insurance funds?
A: Some investors have expressed reservations about the dominant vehicle, i.e. the private equity-type model of infrastructure funds. Therefore, there has been much talk recently about direct investing by institutional investors, but also some action by some well-resourced pension funds and insurance companies. Others are exploring co-investments alongside specialists funds or some sort of syndicate.
Q: What are some of the trends you’re seeing with respect to allocation of funds towards different types of infrastructure, countries/regions, risk profile etc.?
A: The preferences vary a lot across investors. Some people start at home where they feel more comfortable while others seek to diversify internationally early on. Also, no surprise that the interest for Asia and emerging markets has been rising. The majority of investors are looking for stable yield at relatively low risk in infrastructure, this for the purpose of matching long-term liabilities. However, this does not mean there is no demand for more venturous investments into new developments. As a result of the crisis, investors realized how heterogeneous infrastructure can be, and some were surprised by the cyclicality, e.g., of transport assets.
Q: Do you think the size and relative resources the biggest pension funds have at hand are impeding investment activity? We have come a across a number ourselves that face significant challenges because there simply are not enough staff to undertake investments on that scale.
A: Investing in new asset classes poses a big challenge for fiduciaries in every respect: governance, management, operational, risk management, legal, etc. There are specific risk factors in infrastructure that need to be assessed very carefully, in particular the regulatory and political risks. Infrastructure is not just another private investment and there are many stakeholders to want to have a say. It is obvious, that small and medium-sized investors cannot have the resources to do all this on their own.
Q: In your view what makes pension and insurance funds good owners of infrastructure? And what not?
A: Normally, those investors are in for the long term, unless they get heavily disappointed early on. Many of them do not need short term liquidity but do expect to see the illiquidity premium at some stage. I expect institutional investors over time to become more demanding in terms of governance, transparency, disclosure and fees.
Q: What are the greatest challenges these funds are facing when investing in infrastructure? In your view what are some of the things that can be done to overcome these challenges?
A: Good governance and risk management is key at all levels: Project, funds and investors. A major challenge for investors remains the question of: How to best invest? In particular, there is a perceived shortage of appropriate investment vehicles provided by the financial industry. Supply and demand and don’t match too well, e.g., in terms of duration and risk level of funds, or the balance of power between GP’s and LP’s.
Q: What do you think the Euro crisis and global government debt situation (including in the US) will do to accelerate that development?
A: Infrastructure is currently en vogue not only with investors but also with politicians. There will be more infrastructure assets on the market as a result in the public finance crisis in many countries, although the actual process seems to be surprisingly slow. However, there are also certain tendencies of governments trying to impose investments onto domestic investors, raiding pension funds, and similar. This will only make pension trustees only more nervous and could be counterproductive. The Euro crisis does, of course, have effects, among others, on interest rates, (re)financing terms and currency risk considerations of investors. Again, politics could be standing in the way of more private infrastructure investment.
Want to know more about Dr. Georg Inderst and his reports on the sector?
Georg Inderst is an independent adviser to pension funds, institutional investors and international organizations, based in London.
For his public profile please go to:
For his reports on infrastructure please see the following links:
“Infrastructure as an asset class”, EIB Papers, Vol. 15, No. 1, 2010, pp. 70-104
“Pension fund investment in infrastructure: What have we learnt?”, Pensions. An International Journal, Vol. 15(2), May 2010, pp. 89–99
“Pension fund investment in infrastructure”, OECD Working Papers on Finance, Insurance and Private Pensions, No. 32, OECD Publishing, Paris, 2009
For his latest thought pieces “Inflated expectations?” and other articles on infrastructure:
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