One of the key objectives for our research program at the Stanford Global Projects Center is to understand how the largest sources of capital in the world can be channeled into critical infrastructure and development projects most in need of it. In particular, we focus on long-term institutional investors (pension funds and sovereign wealth funds) and private development firms at one end of the spectrum, and government procurement agencies and departments at the other. We are essentially trying to assist in overcoming a number of inefficiencies that seem to be apparent in linking the original source of capital to projects on the ground. In this blog post, we would like to highlight some of the latest trends and issues confronting the institutional investor space; in subsequent blogs, we will showcase some of the work we have done at the government procurement level to facilitate investment.
Institutional investors have long been called upon to help address the global infrastructure deficit but for a variety of reasons, this flow of capital has not been as steady as one would expect. While most in the industry proclaim that governments are not providing enough investable projects and a reliable pipeline, we believe that more work needs to be done to understand how these investors actually operate. Our current research has looked at how institutional investors can adopt strategies that help them achieve their long-term investment objectives. After all, these investors are theoretically long-term investors. Yet through the financial crisis of 2007-08, many of these investors and aspects of the investment management industry were exposed for their short term, opportunistic behavior.
When looking at this topic, it is interesting to see how various global institutional investors have adopted different models for allocating their capital. It would appear that three distinct models have emerged in the space thus far. First, there is the Norway model, which is based on the strategy of the Norwegian sovereign wealth fund of investing primarily in traditional public market assets – whether that be equities or fixed income. Returns are generated through benchmarking public market indexes. The Norway model (advocated by Professor Elroy Dimson from London Business School and Professor Andrew Ang from Columbia Business School) uses a large in-sourced team with a small allocation to external managers to achieve its objectives.
Second, you have the Yale or endowment model (credited to David Swensen, CIO of the Yale endowment), which is based on adding risk to the portfolio by investing in private market asset classes such as private equity, real estate, infrastructure, and hedge funds through external managers. A “top down” model is employed in house for the selection of an asset class/strategy, with an emphasis on selecting the best external managers. Those asset managers then take on most of the responsibility for the investments. The endowment model drives up fees and performance is achieved by getting priority access to well-performing external managers.
The third model is the Canadian model (supported by Professor Keith Ambachtsheer, University of Toronto), first employed by the large sophisticated pension fund investors in Canada. Those funds developed strategies with high allocations to private market asset classes, but invested in them through largely insourced (direct) investment teams to drive down fees. There are advantages and disadvantages of each model and work has been carried out tracking the performance of each.
At our research center we have been working over the last few years to understand, analyze, validate, and propose a fourth model of institutional investment that seems to be increasingly employed by a number of investors – the collaborative model of institutional investment. The collaborative model of investment essentially combines a number of the existing models, recognizing that:
- Private market investing in infrastructure and development projects is consistent with a long-term investment strategy.
- The direct method of investing is a more cost effective means of accessing private market investments.
- Alternative external investment managers are required but the governance needs to be redefined for more alignment.
The collaborative model in many ways reflects the need for these organizations to act in a long-term manner commensurate with their original mission and objectives. The Philippines Government Insurance System partnership with the Asian Development Bank and Dutch Pension Fund, APG to invest into infrastructure is an example of such an arrangement. More recently, the National Investment and Infrastructure Fund (NIIF) announced by the Indian government is designed to leverage partnerships with other long-term investors for investing in Indian infrastructure. Abu Dhabi Investment Authority and Qatar Investment Authority have already signed MOUs to co-invest with the fund in India’s infrastructure sector. Direct relationships between governments and true long-term investors for infrastructure investment are becoming more and more apparent – Queensland, Australia and Quebec, Canada are also examples.
The collaborative model requires existing intermediaries to be reformed and new intermediaries to be formed. Just as new, more aligned platforms are being created to pool capital together, there are also initiatives that are helping to provide “deal” or “opportunity” platforms. Initiatives such as the Global Infrastructure Hub, Global Infrastructure Facility, and AFDB’s Africa50 program, are examples of new intermediaries that are helping to bridge the gap between long-term investor capital and long-term infrastructure assets. The key should be to help build procurement capacity for governments so investment relationships can be developed with true long-term investment partners.
There is still a lot of work to do to bring governments and private institutional investors together efficiently. The collaborative model of institutional investment, which at its core is based on trusted long-term relationships, should provide encouragement for governments looking for trusted long-term partners.