Why are pension investors so interested in infrastructure? In an interview with Het Financieele Dagblad (a dutch newspaper), Gert Dijkstra from APG provides an answer to this question.
The beste example is The Route du Soleil, the highway to the south of France, is a route that has cost many Dutch holidaymakers a fortune. Each year, APG pockets part of the income from these tolls and in so doing, receives an attractive and stable return on its investment. And the icing on the cake is that the income from the tolls rises in line with inflation, as tolls are increased annually. This is extremely welcome because pension funds aim to pay out index-linked pensions.
However, the investors are not always jubilant as investing in infrastructure is not necessarily an unqualified success. For example, in Spain far less use is being made of some newly constructed toll roads than investors had been led to believe would be the case. This is mainly because these toll roads were frequently sited right next to existing, free roads. APG also invested in just such a Spanish toll road and now says that, currently, it looks as though it paid “too much”.
Infrastructure is a relatively young asset class. APG, for example, has only been investing in infrastructure since 2004 and is viewed as a pioneer in the Netherlands, together with the pension provider PGGM. The first roads and hospitals to be invested in were primarily in the United Kingdom and Australia. But in the last ten years, other countries have increasingly decided to finance infrastructure through private financial backers. In the Netherlands, the first project was the overhead wires for the high-speed train. “Once that worked well, more of these types of public-private partnerships followed gradually. And, in the last few years, they have really gained momentum in the Netherlands,” asserted Wim Blaasse from DIF, a manager of infrastructure funds. In this type of public-private project, not only does the government outsource the construction but also the maintenance and financing of, for example, a bridge. Consequently, the investor takes on a far greater risk, and contracts of up to thirty years are commonplace.
According to the institutional investors APG, PGGM and DIF, investing in this type of project is particularly attractive for pension funds as they constitute long-term investments with stable, and therefore predictable, cash flows. In addition, the return is relatively high: around 11% to 12% if the investment is made at the start of the construction work, and around 8% to 9% if it is made at a later stage. And frequently an inflation component is built in—think of those toll roads.
However, on the other side of the coin is the fact that such investments are difficult to convert into cash in the interim. According to Dijkstra from APG, it is pension funds that are prepared and able to bear such liquidity risks. But there are other risks too—one being that the commissioning party, usually a government body, may prove to be an unreliable party. This happened, for instance, with solar energy projects in Spain where the government suddenly cancelled the subsidy, and the financial backers were duped.
Nor are the projects always successful—again the toll roads in Spain come to mind—and pension funds also run a reputational risk. If, for example, a bridge collapses or fraudulent activities come to light during the construction of a port, this could put the fund in a negative light.
In the early years these risks, combined with the lack of accrued experience, were sufficient to deter many investors. But now we are ten years down the line, this situation is beginning to change and far more investors can see the advantages of investing in infrastructure; recent players in the market include large investors from Asia and Canada. Furthermore, the current market situation is encouraging this type of investment as the low interest rates make it difficult to earn good returns in the long term, a situation which has placed Dutch pension investors under greater pressure.
According to APG, bids are sometimes so aggressive that the provider feels obliged to withdraw, which can be hard to swallow. One of the instructions the pension provider received from its largest client, the pension fund ABP, is to double its interest in sustainable energy in the next three years, which in Dijkstra’s words will prove “quite a challenge.” Numerous sustainable energy projects are deemed infrastructure; consider, for example, wind energy.
The competition is, moreover, limited to a number of large players. Dijkstra: “You must be able to write a check for a couple of hundred million euros.” This makes it impossible for the smaller pension funds to participate in infrastructure projects directly; their only option is to invest through external funds.
Read the whole article in the Financieele Dagblad (in Dutch and account required)