Pension Funds and Infrastructure Sector

Infrastructure funding can be very important for any economy. This is the reason that governments all over the world want to continuously upgrade their infrastructure.

Even a country like America which is one of the most developed nations in the world has been planning to spend $3 trillion on upgrading its infrastructure.

Just like America, countries around the world believe that having a well-developed infrastructure will help lower their cost of production and hence is likely to make them more competitive in the international market.

Infrastructure projects require a huge outlay and involve significantly large periods of time.

Pension funds control large sums of money and want to invest it for a long period of time. Hence, it is believed that pension funds can be the perfect financiers of infrastructure projects.

In this article, we will have a closer look at the various ways in which pension funds can help in increasing investment in the infrastructure sector.

Why Should Pension Funds Invest in Infrastructure?

Pension funds have been trying to earn higher returns because of the low yield which is currently being offered by debt products. Hence, they have been taking excessive risks in order to enhance their return.

Infrastructure projects are a nice way to earn a yield that is higher than conventional debt products without having to take on too much risk. This is because of the fact that infra projects are generally asset-heavy. Hence, pension funds can create a claim on these assets which helps them secure the loan, thereby reducing the chance of default.

As far as the government is concerned, pension funds are a cheaper and more reliable source of funds as compared to market investors. The government does not have to incur the cost of raising funds every time. Also, they can raise funds more predictably since the inflow of money into pension funds is more or less constant.

Hence, it is obvious that if pension funds start investing in infrastructure, then the result is a win-win deal for both parties.

How Pension Funds Invest in Infrastructure?

Now, since we have ascertained that investing in infrastructure is indeed a good deal for the pension funds as well as the government, we now need to understand the various ways in which these investments can be made by pension funds.

1. Public-Private Partnerships: Pension funds can use the public-private partnership route in order to tap infrastructure projects. These pension funds can be the private party that funds infrastructure projects. These projects may be executed by government authorities.

   In many cases, the execution is also done by a private contractor. However, the pension funds and the private contractor can collect the proceeds from the project for a certain amount of time. After the time period has elapsed, the project can be handed over to the government.

2. Special Purpose Vehicles: In many cases, pension funds create special purpose vehicles for investing in infrastructure projects. This is because they do not invest the entire amount. Instead, they provide a certain amount of capital to the special purpose vehicle. At a later stage, the vehicle is able to raise the balance capital from banks. This allows the pension funds to make leveraged investments.

3. Private Debt Financing: Since pension funds do want to take over the risk of the project, they want to make indirect investments with limited liability. Most pension funds do not have any expertise in the execution of infrastructure projects. Hence, they tend to prefer a structure that helps them focus on financing which is their core competency while outsourcing the actual project execution to a contractor. This is done by financing the private debt of such contractors.

   There are several contractors who undertake infrastructure projects and sell bonds to finance these projects. Some pension funds regularly finance these projects by buying these bonds.

4. Sovereign Debt Financing: There are other instances where pension funds do buy bonds for infrastructure projects but these bonds are issued either by a government or a quasi-government entity.

   The benefit of buying from the government is that there is almost no chance of default. Also, there are many tax breaks for buying such debt since it helps the government build infrastructure and develop the overall economy.

Regulatory Limits on Infrastructure Spending

There are certain problems that limit the exposure of pension funds to the infrastructure sector.

One such issue is that in many parts of the world, there are regulations that limit the amount of money that can be invested in each sector. As a result, the pension funds can only allocate a limited amount of funds toward the infrastructure sector.

Regulatory Limits on Concentration of Assets

Apart from the regulatory issue mentioned above, there are also many other regulatory issues. For instance, in many parts of the world, regulators prohibit pension funds from having a high degree of exposure to the same entity or even the same geographical location. This often ends up becoming a roadblock that limits the amount of funds that can be allocated towards the infrastructure sector.

The bottom line is that pension funds are eager to invest more money in the infrastructure sector since it is a win-win situation for both the government as well as the fund. However, there are some limitations that prevent excessive exposure to the sector. It can be argued that such limitations are for the benefit of the pension fund.