The Buzz on the Street: Can institutional investors really close the infrastructure gap?
Once again, infrastructure is a hot topic. Not since the first waves of energy, water and transport privatizations in the early 1990s has infrastructure been a central topic in the daily discourse of the media, of the development community, of economists and financiers. Now, governments are crying for more of it, new development institutions are being built around it and even the IMF is asserting its central role in economic growth.
Not only has infrastructure re-emerged as a popular, nearly consensus solution to the economic and societal woes of developing countries and industrialized nations alike, but the font of the resources needed to fill the infrastructure financing gap has also been identified. Suddenly, it is impossible to walk through London, Washington, Paris or Singapore without bumping into a conference on institutional investors in infrastructure. The G20 has discovered the link along with their business counterparts at the B20. So too has the World Economic Forum, the OECD, the UN and the international financial institutions. Match the long-term liabilities of pensions and insurance plans with long-term assets, the mantra goes, and the infamous infrastructure gap will close. Win-win.
If only life were so easy.
I am reminded of the old expression, “If your grandmother had a beard, she’d be your grandfather.” In this case, if infrastructure was perceived by investors as a truly stable, risk-adjusted investment, it would already be able to attract the financing it needed. There would be no gap. The table below shows both how much resources institutional investors have in terms of assets under management versus how little is likely going into either infrastructure of EMDE investments.
Table 1: Assets under Management in Institutional Investors and Estimates of Share of Investment in Infrastructure and in EMDEs 
Some institutional investors found their way into infrastructure assets as far back as the 1990s and have been cautiously growing their investments, attracted by the long-term demand, steady growth and regulated returns. A few of the Canadian pensions and Australian super-annuation funds invest 10 to 12 percent of their assets in infrastructure while equity funds that focus on infrastructure and related businesses in emerging markets, such as IFC’s Asset Management Company, are growing on the tide of this burgeoning market. To date, the pensions are mostly exposed in equity investments in the regulated utilities of Europe, North America and Australia while the funds are focusing on higher risk, higher return investments around the edges of infrastructure—in gas platforms and mobile licenses, in telecom towers, container terminal operators or the occasional power plant.
The real test of patience and stability will come when debt and debt-like products from the broader range of institutional investors begin flowing into large-scale, basic service infrastructure—transport, power, water and sanitation and the backbone of telecom services. And since infrastructure is highly leveraged—typically 70 to 80 percent debt in the capital structure—the broader infrastructure financing gap will not be closed until this happens.
A few questions surround these ambitions:
- Why would a development institution care so much about institutional investment in infrastructure?
- What are the hindrances to this happening?
- What are we doing about it?
Why do development finance institutions care about institutional investors in infrastructure?
Both the public and private sector arms of the development banks and international financial institutions care about the potential of institutional investors in infrastructure for three reasons. The first is affordability. Maturities and the cost of capital drive the cost of service for consumers of basic infrastructure more than any other area of the economy. This is because the lifecycle cost of operating infrastructure services is predominantly capital cost. By contrast, the major part of education and health care services costs are derived from salaries of teachers, administrator or health workers, but the all-in costs of building and operating roads and rail, power generation, transmission and distribution, water and sanitation are mostly attributed to the hard infrastructure. Amortizing those costs over long periods of time and doing so with as low interest rates as possible has a direct impact on the affordability of service, and hence on poverty alleviation.
While designing the Global Infrastructure Facility (GIF), we looked at a large power project about to go to market in West Africa. We simulated what would happen to tariffs if the short-term commercial debt that was being offered could be replaced with longer-term debt with the cost of capital and maturities of institutional investors who had approached us about joining the GIF as advisory partners. The consumer tariff associated with that investment would have dropped nearly 20 percent, representing about one-tenth of the total income for a household in the bottom quintile of earnings.
Second, the interests of pension funds and insurers often align with the interests of governments, consumers and development institutions alike. Both groups—private and public—like steady economic growth, stability and no “drama.” That means environmental and social safeguards that would meet the standards of a board of trustees and the interest of pensioners. It means lack of tolerance for corruption, scandal or other forms of governance issues. While the private sector generally wants to avoid scandal, an investor that plans to live with an investment for 20 or 30 years and which is exposed over that lifetime to a high level of stakeholder scrutiny is less likely to invest in a company that has cut corners.
Finally, derived from the first two points, but worth special mention is the” virtuous cycle.” That is, the economic and political conditions required to make an asset attractive to long-term investors are desirable for a number of reasons which spill over to the economy. For example, in order for an investment to offer stable and reliable pricing, a government must commit to uphold contracts and to put in place regulatory structures that are viable and objective. World Bank research shows that infrastructure investment is much more sensitive to such expressions of sovereign risk than other forms of foreign direct investment. Those governance achievements will reduce risk perceptions and improve the overall investment climate for governments. In other words, if a government can do what is necessary to attract long-term debt and fixed income products to its infrastructure services, the likelihood of that asset providing services over the long-term increases and so does the ability of the government to attract investment generally.
What are the hindrances to institutional investors in infrastructure?
Coming up with one magic bullet that pulls in the most patient capital of institutional investors may not be possible. First, not all institutional investors are created equal. Pension funds, insurance companies, reinsurers, state development banks, insurance funds and sovereign wealth funds all have different mandates and different return expectations for their investments. Their governance structures and their investment cultures vary as does the applicability of financial regulations. Even within the smaller universe of pension and super-annuation funds, we see stark differences among them—from risk appetite and portfolio diversification targets, to the in-house (or not) ability to do risk assessments of individual investments.
By now, Moody’s analytical work showing that default rates of infrastructure versus corporate debt has found its way into the PowerPoint presentations of investment advisors and into strategic discussions. At the IFC, analysis of the syndications group suggests their infrastructure and extractives investments in emerging markets and developing economies are producing higher returns with lower failure rates than like investments in OECD markets. This may be counter-intuitive to many investors given the particular risks of infrastructure that make can investments challenging—currency exposure, political sensitivity, environmental and social pressures, to name a few. But because these risks have to be addressed up front in order for the project to come to market, the bias works in favor of this relatively small world of investment opportunities.
The greatest challenge then is expanding the world of investment opportunities—of growing the pipeline of investments so that they begin to look like an asset class. In all the markets of the emerging markets of East Asia and the Pacific, for example, we see no more than 80 or so infrastructure projects with any form of private participation come to close in a year. That includes everything from small water treatment plants to IPPs toll roads and mobile licenses. It represents less than 2 percent of infrastructure investment in that booming region.
Globally across the developing world, no more than 15 percent of all infrastructure investment has some form of private participation. More to the point, according to data extracted from the World Bank’s PPI Database, over 60 percent of debt investment in Public infrastructure projects comes from public sources, primarily state-owned development banks. (See chart below.)
Chart 1: Private Investment in Infrastructure / Share of Public versus Private Debt and Equity in PPPs
The private sources are predominantly commercial banks offering relatively short tenors. If we want the total envelope to grow, neither the public exposure nor the short-term financing options are sustainable.
That means a steady and large enough portfolio of assets entering the market that regulators begin to treat them consistently, that institutional investors build targets into their portfolios and risk assessment becomes more standardized and predictable.
What are we doing about it?
The core business of institutions like the Technical Partners of the GIF will continue to revolve around the soup-to-nuts of preparing infrastructure for investment. The public sector divisions of the MDBs working with governments in energy, water, transport and communications will continue to focus on market structures, regulatory capacity, pricing and affordability, environmental and social sustainability of projects as well as the public financing of investments that provide for public goods and address poverty needs and market failures. The private sector sides will continue to expand investment—both equity and debt—and explore the use of new risk instruments. Whether guarantees, insurance products or infrastructure bonds, project finance continues to expand the use of instruments that distribute risk, mitigate risk or lower risk for and investors, operators and financiers.
More directly, we are creating facilities such as the Global Infrastructure Facility (GIF) that can offer resources to build out pipelines as well as the partnership needed to do so correctly. With the right consultations, advice and technical inputs, more investments can be designed and brought to market that are structured with long-term commercial viability in mind. This is not only what the investors respond to but it is also what the governments demand and what the consumers deserve.
Annex: Scope of Institutional Investment in Infrastructure
- In June 2014 over US$296 billion unlisted funds were under management globally, with over US$100 billion in dry powder.
- Out of the total unlisted funds under management only US$26 billion or 13% of funds were invested in EMDE.
- This amount (US$26 billion) corresponds to roughly 1% of the total investment commitments to core infrastructure (Energy, Transport and Water) in EMDE.
- Listed funds, which make up a smaller amount of the market, were more geographically dispersed than unlisted funds, with approximately 24% of funds focused on EMDE.
(Source: Preqin 2015)
Funds Committed to Infrastructure By Type
In 2014, approximately 57 percent of the funds committed to infrastructure were from Public Pension Funds, Asset Managers (16 percent), Government Agencies (13 percent), Sovereign Wealth Funds (7 percent) and Superannuation Schemes (7 percent).
Unlisted Infrastructure Assets Under Management
December 2004 to June 2014 (billions of U.S. dollars)
Predominance of Public Financing in the Largest EMDEs (2012 - H1 2014)
Which Instruments Are Used to Finance Private Infrastructure in LICs and MICs?
Breakdown of Infrastructure Financing in MICs (2010-2014)
Breakdown of Infrastructure Financing in LICs (2010-2014)
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