Investing in Infrastructure

A Global Perspective

Globalisation isn’t quite the buzzword it was twenty years ago. Nevertheless, over the past few decades we have seen the steady erosion of the barriers which have traditionally separated nation states. Retirement income systems remain firmly entrenched within the existing mandate and structure of the nation state. Public policies should reflect the particular social, economic and cultural norms of sovereign nations, but there is still great value in international dialogue on the challenges and opportunities which superannuation and pension funds globally share.

I recently sat on a panel at the World Pension Summit in The Hague with Bernard Casey, principal research fellow at the University of Warwick and associate professor at the London School of Economics. I had the opportunity to discuss with him the global challenge of bridging the infrastructure deficit and the role that superannuation and pension funds globally can play, while understanding the challenges and risks it poses to member retirement incomes both in Australia and globally.

The infrastructure deficit

A common challenge for Australia and many other nations is the gap between the current levels of investment in infrastructure, and the growing infrastructure needs as populations increase and existing infrastructure requires modernisation. Infrastructure Australia has estimated that the economic cost of underinvestment is projected to reach $53 billion a year by 2031.

The recent ALP policy announcement proposing a $10 billion financing facility for Infrastructure Australia comes on the back of the establishment of the Global Infrastructure Hub in Sydney and Asset Recycling Initiative, all indicating an increased public attention in Australia.

The spectre of the global infrastructure deficit looms similarly grand in stature. The World Economic Forum estimates the global infrastructure deficit as being around $1 trillion every year. While the specifics of the exact amount of the deficit can be debated, it is clear that there is a significant need for investment in infrastructure both at home and abroad.

The challenge facing governments is significant; however the projects necessary to reduce the deficit in infrastructure both domestically and globally may present a strategic investment opportunity for Australian superannuation funds.

Investment by superannuation and pension funds

Investing in infrastructure is commonly considered as attractive to long term investors such as superannuation funds. It is less volatile in valuation, not strongly correlated with the business cycle, often monopoly-like and a good inflation hedge where it is built into revenue streams. However, there are also specific risks in investing in infrastructure, with liquidity risk, asset valuation risk and special political risk being typically pronounced.

Around one third of APRA regulated superannuation funds report an allocation of assets to infrastructure, and these funds generally allocate between 2% and 10% of the fund portfolio for infrastructure investments, with industry funds allocating eight times the assets of retail funds to infrastructure. APRA regulated superannuation funds report approximately $55 billion in asset allocation to infrastructure, of which about half is invested in unlisted domestic infrastructure, with a quarter each in both listed infrastructure and international infrastructure. This figure is likely to be understated due to indirect investment and classification as alternative assets. The OECD estimates that the allocation is somewhere between 5–8% of assets.

Professor Casey suggests that “it is similarly very difficult to assess the allocation to infrastructure assets by European pension funds, being difficult to distinguish infrastructure from a broader heading of alternatives, or unlisted property, or the like. So, we have guesstimates.”

Nevertheless, Professor Casey points towards the best guesstimates from the OECD and European Investment Bank, which suggest a developing interest, with UK pension funds allocating about 1% of assets to infrastructure. Dutch pension funds are starting to dip their toes in the water, and Danish and Finnish pension funds have started to show interest in renewable energy infrastructure. Movement might be slow, but we are starting to see a developing appetite to invest in infrastructure globally. However, so far, the appetite is for “brownfield” rather than “greenfield” investments — it is not the construction of new infrastructure but the management (but sometimes the enhancement of existing) infrastructure. Pension funds are rarely willing to take on construction risk.

Challenges and risks in infrastructure

The infrastructure deficit isn’t a problem which superannuation and pension funds are responsible for, but it may create investment opportunities. As pioneers, superannuation funds are well positioned to capitalise on this, yet there are also challenges.

Professor Casey highlights the unique aspect of infrastructure investment by Australian superannuation funds compared with Europe and North America is that, in Australia, it is defined contribution funds rather than defined benefit funds that are investing in infrastructure. This accentuates two risks — those of liquidity and valuation. In Australia, pension savers can switch funds at little notice and almost as often as they like. Yet infrastructure assets are highly illiquid and most are not “listed”. He suggests that “defined contribution superannuation funds rely on high levels of inertia to manage liquidity risk.”

The fact that the investments are not listed means that assessing the value of a fund and so of an individual account is also complex. Professor Casey explains that infrastructure asset valuation is generally “mark to model” rather than “mark to market”, raising the prospect of a process which is “10% science and 90% art”. To some extent, what an account is worth depends upon the model and the assumptions of the modeller. Revaluation can shift values from on date to another and a saver might be on the “wrong” or the “right” side of that revaluation.

Indirect infrastructure investment vehicles are making infrastructure assets more accessible to investors who don’t have the traditional profile of an infrastructure investor. Equity and debt infrastructure investments can be accessed through an intermediary such as wholesale or listed managed investment scheme. There are over 140 such schemes globally, and there are challenges faced by indirect investment.

Indirect infrastructure investment vehicles are making infrastructure assets more accessible to investors who don’t have the traditional profile of an infrastructure investor. Equity and debt infrastructure investments can be accessed through an intermediary such as one of the 140 odd wholesale or listed managed investment schemes globally.

The 2015 Preqin Global Infrastructure Report outlines an increase to $105 billion in dry powder in managed infrastructure schemes (capital committed to unlisted infrastructure but not yet called up) in 2014, representing over a third of all unlisted infrastructure assets under management globally. This can easily be seen as a sign that there might be too many dollars chasing too few deals.

The strong demand for infrastructure investments (and the deficit in projects) will mean that there will continue to be strong competition between managed infrastructure investment schemes, pension and superannuation funds investing directly, international financial institutions and sovereign wealth funds. Positioning to manage the associated risks once the supply of infrastructure projects increases will be an important factor for superannuation funds continuing to lead the way internationally.

Maintaining focus

The danger in linking retirement income assets with the infrastructure deficit is that there can be uncertainty as to what the objectives of the investment are. Whether in Australia or internationally, the fundamental objective for the investor must remain the risk profile and associated capacity for generating wealth through income and capital gains.

The broader economic and social utility of infrastructure can’t be ignored, yet it’s critical that investors don’t attempt to identify and measure such objectives in assessing the appropriateness of making, maintaining or disposing of an infrastructure asset. Infrastructure investments are not quasi socially responsible investments. The responsibility for ensuring that broader social and economic objectives of infrastructure are met, and that the agenda for a pipeline of appropriate infrastructure projects with attractive market and commercial conditions are planned and initiated, rests with national and state governments. Superannuation and pension funds need to be prepared for the risks and challenges once the opportunities present themselves.

This article was originally published in the November 2015 issue of Superfunds Magazine, published by the Association of Superannuation Funds of Australia.

I can be contacted at jsteffanoni@qmvsolutions.com