By Saliem Fakir · 31 Mar 2010
When Minister Ebrahim Patel released his fledgling department’s medium-term strategic plan, he indicated that the Department of Economic Development would investigate the use of pension funds for the purposes of infrastructure development and repair.
No sooner had he announced this, did some economists, in a typical knee-jerk reaction, jeer the idea conjecturing that it was bad. In contrast, there have been some others from the same quarters (private capital markets) who thought it might actually be a good idea.
Some of the negative sentiments are driven by view that the state is a poor decider of good investments. If infrastructure is to be owned and managed by the state, then its competency to do good with these assets is always questioned.
There are risks, of course, like any investment.
The kinds of risks that come with infrastructure projects relate to construction risks, such as, the project not being completed on time, incurring cost overruns, encountering operational risks (where an asset is managed poorly), coming across business risks where competitors compete to provide the same service, running into debt risks (where too much debt subject to interest rate hikes is accumulated), stumbling upon political risks (such as corruption) and regulatory risks where tariffs do not rise timeously to accommodate inflation and operating costs.
In South Africa, some of these risks are real. We have witnessed delays in the building of new power plants; we experience the problem of corruption; at the same time, some assets are poorly managed. All this has served to caste a pall of doubt.
There are, though, also some good reasons why public sector pension funds can aid the development of public goods. Appreciably, they can make capital available on more preferential terms than private investors are likely to.
South Africa is not new in thinking this way. Two years ago, India also debated the issue while putting a strategy in place to use pension funds to boost infrastructure development.
Sri Lanka has already tapped into public pension funds to partially fund its new power stations. At the same time, Latin America has a long track record in the use of pension funds for critical and targeted infrastructure.
This shift is not only taking place in emerging economies. The appetite for risky investments, like in stocks, is diminishing and marks a change of mood even in sophisticated financial markets in developed economies.
In the United States of America (US), for instance, private pension fund holders are looking for less risky options and willing to buy more long-term bonds with good yields to spread risk, such as, infrastructure bonds offered at the state or municipal levels.
Private pension funds in the US are doing so quietly and moving more rapidly than government public investment funds, as they look to invest in infrastructure assets. Investor surveys have shown that many of the mature private funds will transfer as much as 10% of their investments from stocks into less risky long-term bonds.
In January 2010, the United Kingdom’s (UK’s) Alistair Darling, Chancellor of the Exchequer, opened discussions about a government-backed infrastructure bank that would attract pension funds and help the UK finance a much-needed backlog in infrastructure.
If there is a good return on investments and low risk then investments in pension funds need not threaten people’s life savings, but rather enhance the value of the portfolio mix and spread.
The use of public pension funds can rouse political jousting, as they could displace private sector participation in public-private-partnerships (PPPs). However, the sentiment against their use tends to be purely ideological.
PPPs were once thought of as useful to attract private capital, while scarce government resources could be diverted to other uses. But the tide is turning against PPPs.
PPPs were deemed to be the convention in the 1990s, but of late the idea of the private sector having a lucrative hand in publicly paid for projects is increasingly coming under pressure, even in market-friendly countries.
In the US, PPPs, which relied on toll or other user fees to pay the debt portion of infrastructure projects or that demanded high return ratios for private equity stakes, resulted in American taxpayers’ money contributing generously to the coffers of foreign investors and sovereign funds, rather than in their own public funds or state coffers.
South Africa’s investment in infrastructure has long been neglected. The backlog goes back at least thirty years or so.
The current proposal is that at least 5% of South Africa’s public pension funds be directed towards development projects through the creation of a government development bond.
Infrastructure investments open up a new set of opportunities for the Government Pension Fund and its investment arm, the Public Investment Corporation (PIC), established in April 2005, as well as the potential to diversify their portfolios.
PIC is wholly owned by the South African government and is the single biggest institutional investor in South Africa. PIC manages close to R700bn worth of assets. Public sector retirement funds are estimated to be about R1.3 trillion.
PIC, thus far, has been used to promote BEE deals in publicly listed companies -- some with questionable returns.
The 5% allocation is not inconsistent with trends being followed by other pension funds around the world.
The big US pension fund, Calpers, issued an investment policy decision to invest 3.5% of its allocations to infrastructure assets. The same is true for the Irish National Pension Reserve Fund, as well as Canadian and French public pension funds.
In fact, the Canada Pension Plan Reserve Fund is doing an about turn. In 1966 it held significant government bonds that helped fund social infrastructure. These investments were stopped in 1998 by the Canadian federal government, as it directed funding to private investments (stocks and real estate).
Having burnt their fingers during the financial crisis; public pension funds are seeking to move out of the speculative markets to areas where returns are reasonable and more stable.
However, the interest in pension funds must not be seen in isolation from the hunger for capital.
The scale of demand for infrastructure projects, as part of government stimulus packages, will always surpass the supply of capital available from the private sector. It is one of the reasons governments are exploring the use of pension funds to close the gap.
For example, in East Asia, financing needs for infrastructure development amounts to about US$228bn per year for the period 2006-2010, but only US$48bn has been secured.
Globally, the OECD estimates that the growth in demand for investment in infrastructure will be around 3.5% of world GDP or about US$2 trillion per annum -- mostly in emerging economies in need of power, railroads, roads, telecommunications and water infrastructure.
This demand is mainly in what is characterized as economic infrastructure and does not take into account social infrastructure like schools, hospitals and so on.
This gap also needs to be filled.
The attractiveness of pension funds is that they offer long-term capital that can be linked with long-term revenue streams to match pension fund liabilities over the same period.
Private investors are loath to hand out cash for very long periods. In general, their risk appetite is low and they are inclined look for quick exit strategies for their investments. However, the longer the period over which a debt has to be paid, the lower the cost of paying the capital part of the debt.
This makes pension funds an ideal recruitment for investment.
The move towards pension funds has to do with the nature of the present market. The recession has affected national budgets’ ability to tax more out of their citizens and drop tax receipts from consumables. It has resulted in higher than usual budget deficits as well as a, generally, high cost of capital in the commercial markets.
These constraints have driven the pursuit of cheaper sources of capital and this accompanied by the lack of credit availability in the commercial markets has pushed governments to look elsewhere.
However, even if private capital was available, governments in emerging economies are loath to cede financing of national assets to foreign private investors.
Domestic pension funds, in a way, also meet the rising penchant to ‘nationalize’ capital sourcing and flow of returns.
The shift to infrastructure also marks recognition that asset classes, which are subject to the movement of market sentiment, are unreliable because of the volatility and high risks they impose, especially, if significant portions of assets are invested in stocks and currencies.
Infrastructure assets are viewed as more tangible than stocks. They are regarded as stable, have predictable cash-flows, long-term income streams that are inflation linked, low default rates and their public goods status makes them socially responsible investments (SRI).
All of this will come into play in the debates around the use of state pension funds for the purposes of meeting the country’s developmental objectives via the provision of strategic infrastructure.
The advantage is that citizens who are part of public pension schemes can enrich their own portfolios rather than see their payments for services enrich private funds or overseas investors.
In this regard, one must conclude that it is better to have an informed debate on the merits of the issue than listen to howls from disturbed economic minds.