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In a new study entitled "Pension Fund Investment in Social Infrastructure: Insights from the 2012 reform of the private finance initiative in the United Kingdom", EDHEC-Risk Institute has identified two fundamental issues that make social infrastructure potentially unattractive to pension funds: in-built political risk and limited asset pool size.
Social infrastructure investments deliver public assets and services, such as schools and hospital buildings, in exchange for a revenue stream paid directly by the public sector. It is typically opposed to economic infrastructure, which collects revenues from end users and can include toll roads, airports or power generation.
According to the author of the research, Frédéric Blanc-Brude, Research Director at EDHEC Risk Institute—Asia, addressing the uncertainty created by political risk through a transparent and independent regulatory framework for long-term buy-and-hold investors like pension funds would make individual social infrastructure assets much more desirable investments in an asset-liability management context. However, until a much larger asset pool has been created, it is unlikely that pension funds will treat social infrastructure as an asset class demanding specific allocations, which would considerably increase the flow of funds towards social infrastructure that cash-strapped governments are now keen to see.
The mechanism creating the investment characteristics of social infrastructure investment generates political risk for investors: the political cycle almost always leads to the public sector reneging on prior commitments and re-regulating contracts. The current reform of the PFI is a case in point. Future reforms should aim to create a transparent and independent regulatory framework committing the public sector more effectively, while capping returns.
The current size of the social infrastructure asset pool (USD100bn invested globally between 1995 and 2010, mostly in the UK) is such that modest allocations by major pension funds would lead to a rapid rarefaction of these assets. This could be the most challenging dimension of the promotion of infrastructure investment by pension funds. Infrastructure debt – the bulk of social infrastructure capital investment – is unlikely to be treated as a separate asset class by pension funds and thus to be the object of a specific asset allocation at the strategic level.
A copy of the EDHEC-Risk Institute study can be found here: EDHEC-Risk Publication Pension Investment in Social Infrastructure
Written by STEPHANE COLOMBANI
March 7, 2012