At the end of 2011, I made some bold predictions for SWFs in 2012. For example, I said that data architecture would become increasingly important for institutional investors (It has). I said that a bunch of countries would look to set up new SWFs (they have; see Slovenia, Kenya, Panama, Mongolia, Gabon and others.) I said that Africa’s appeal would grow among institutional investors (It has). And I said that the IFSWF would transition from a silent, placeholder-of-an-organization into a vibrant entity that effectively champions the interests of its constituents (And it’s starting to do so).
So as we get close to the halfway mark for 2012, you’ll forgive me if I’m feeling a bit, well, smart. But as Dr. Henry Jones, Jr. (aka Indiana) would say, ‘that’'s usually when the ground falls out from underneath your feet.’ ...You could be more right than you know, Indy.
My number one prediction for the year was that every institutional investor in the world would begin planning how to allocate (or increase their allocation) to infrastructure. That’s a strong prediction...which appears to be wrong. New data suggest that institutional investors are actually pulling back from the asset class:
“In the past five years until the end of April 2012, pension funds around the world have reduced their allocation, or deployment of capital, to such investments by 8% to USD 49.46 Billion...”
What the heck?
These pension funds should be gobbling up infrastructure assets to match their long-dated pension obligations. As an asset class, infrastructure has high barriers to entry, large economies of scale (e.g., high fixed, low variable costs), inelastic demand for services (creating pricing power), low operating costs, high target operating margins, and long duration (e.g., concessions of 25 years, leases of 99 years). These characteristics provide investors with uncorrelated returns and long-term, stable cash flows. Infrastructure also offers a good inflation hedge with low default rates. All these factors should make the asset class quite popular among institutional investors and especially pension funds.
So what gives? Why are pension funds moving away from this asset class when it seems obvious they should be going in the other direction? As it turns out, the answer is actually quite simple: Limited access. There’s really no easy or appealing way for the community of institutional investors to get exposure to these assets in their portfolios.
The existing third party products aren’t all that appealing due to misaligned incentives and high fees. And while there’s a growing interest to own infrastructure assets on a direct basis, it’s very challenging to build up the internal capabilities to go down the direct-investment path. So it’s very hard. And this has kept many would-be infrastructure investors on the sidelines.
In short, institutional investors haven’'t decided they don’t like infrastructure. Instead, I would interpret the evidence as a sign that we have to continue to develop and expand access points, something that pension fund OMERS, foundation Rockefeller and Silicon Valley startup Zanbato are all working toward.
And, by the way, this is one of our big projects at Stanford University: building out our understanding of how to improve these access points for investors with the broader goal of unlocking institutional capital for infrastructure. I guess I’'ve got more work to do...
