The Toronto skyline is framed by construction cranes at a development site in Toronto, Ontario on Oct. 30, 2015.Fred Lum/The Globe and Mail
It's hard to feel sorry for retirement fund managers. They are paid well to look after our pensions but put yourself for a minute in their shoes.
Where do you invest the money? Stocks are risky or just overpriced; Canadian real estate is in a scary boom but expect a bust when you want to sell in 10 years time. The biggest headache is government bonds: so expensive that yields are close to nil and in some markets already negative. With no income, how does a pension fund meet its liabilities?
The solution is to do what governments are not doing: invest in things that we all use, such as roads, railways, ports and airports. In quest of that increasingly rare commodity, the safe income-generating investment, pension funds are moving out of the plain vanilla world of stocks and bonds into a more complicated world of infrastructure or structured finance. It's a category blandly described as "other" by actuaries. It's the stuff that isn't equities, bonds, cash or real estate; only a decade ago it amounted to 2 or 3 per cent of even the larger pension schemes. A recent survey by the U.K.'s Investment Association found that "other" had swollen to 13 per cent of its asset allocation universe.
Big Canadian public-sector pension funds, such as Ontario Teachers' Pension Plan, are at the forefront of building positions in the "other" category of investments. At the end of last year almost a one-10th of the Teachers fund was invested in infrastructure. The portfolio included stakes in airports in Birmingham and Bristol in the U.K. as well as Brussels and Copenhagen; Teachers has also invested in water companies in Chile and container terminals in Vancouver, New York and New Jersey. And it has acquired an interest in Camelot, the operator of Britain's National Lottery.
You can see why such investments look attractive to pension fund managers. In a world of volatile capital markets, where a safe income is either very expensive to purchase or just not available, what could be better than an airport or a water utility? It's a public good with a very reliable and recurring stream of income. It is also regulated by government which gives the investor the extra assurance of oversight by a public watchdog.
If public utilities are such good investment bets, chased by big pension funds, it begs the question why governments are reluctant to build more roads, railroads and airports. The money is out there, there is investor hunger for income and a bit of Keynesian pump-priming would probably go down well with the voters.
Canada is beginning to dip its toe in the water with a federal transit fund intended to help cities to upgrade their networks. The Liberal government campaigned on a promise to invest in the country's crumbling infrastructure, and in the spring announced it had allocated $10-billion for "shovel-ready" projects over the next two years in the first phase of a 10-year plan.
According to the World Economic Forum there is a $1-trillion (U.S.) gap every year between what the world needs to spend on infrastructure and what is invested. McKinsey reckons that over the next 15 years the global infrastructure investment shortfall in the G20 group of nations is $20-trillion. A lot of that is in emerging markets but any tourist who has recently arrived at a New York airport and tried to make their way into the city might think a lot of that shortfall was in America. Why not just build stuff and issue bonds to pay for it?
Of course, it isn't that simple. Infrastructure has to be built before it generates income. Governments worry about loading the public balance sheet with more debt for good reason: it increases the tax burden and could, among the more fiscally challenged nations, provoke a cut in the sovereign debt rating. That could have a dramatic impact on the cost of borrowing which, again, threatens the taxpayer.
The fashionable solution is public/private partnerships, a path well-trodden in the U.K.. but one which has led to accusations that private companies were enjoying bumper profits from long-term contracts at the public expense. A large part of the problem lies in attempting to marry the different perceptions of risk and reward between public and private sectors. The former tends to measure its cost of capital according to the "risk-free" rate of a sovereign borrower. For the government, money is cheap (indeed so cheap that central banks are happy to make more of it on a merry whim) but private pension investors, take a different view. Hence, the disappointment when new, privately funded infrastructure projects, whether roads or trains, turn out to be very expensive for the consumer.
But these tortuous negotiations over myriad infrastructure projects around the world are ignoring the big picture: a world awash with cash, investors fearful of risk, and a desperate need for investment in public goods. Government bond yields have collapsed and even their liquidity, once a guarantee, is coming into question. Thanks to so-called quantitative easing (to lay folk, that's means money-creating), the Bank of England is now one of the biggest buyers of U.K. bonds. It has increased its hoard of them by 25 per cent in recent years, further reducing their attractiveness to pension investors.
Once the bulwark of a sensible retirement fund, bonds are in a terrible mess. Speaking to the Financial Times newspaper, David Hunt, head of PGIM, the Prudential's money management arm, said low interest rates were causing "substantial systemic risks." Paul Elliott, the boss of the $28-billion hedge fund, Elliott Management, reckons that the bond market is "broken." With $13-trillion of bonds now in negative-yield territory, he warned his investors to stay away from the assets, which are in "the biggest bubble in history".
The solution must be to create institutions that can build public infrastructure but keep it off the public balance sheet, while enabling private-sector funds to finance development. Infrastructure banks have done this effectively in the past, such as the investments in Eastern Europe made by the European Bank for Reconstruction and Development. A institution that owned a large portfolio of utility investments with regulated revenue streams in developed economies ought to be a very attractive proposition for pension investors.
In any event, it's better than chasing negative-yielding government bonds, high-yielding oil exploration stocks or subprime U.S. mortgages.
Carl Mortished is a Canadian financial journalist based in London.