OECD Working Paper: Pension Fund Investment in Infrastructure: A Comparison Between Australia And Canada

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Australian and Canadian pension funds have been pioneers in infrastructure investing since the early 1990s. They also have the highest asset allocation to infrastructure around the globe today. This paper compares and contrasts the experience of institutional investors in the two countries.

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Australian and Canadian pension funds have been pioneers in infrastructure investing since the early 1990s. They also have the highest asset allocation to infrastructure around the globe today. This paper compares and contrasts the experience of institutional investors in the two countries looking at factors such as infrastructure policies, the pension system, investment strategies and governance of pension funds. The ‘Canadian model’ and the ‘(new) Australian model’ of infrastructure pose a challenge to the ‘private equity model’, dominant in Europe and the USA. Important lessons can be learnt by both policy makers and investors.

Executive Summary

Many governments have decided to encourage private investment in infrastructure to bridge the infrastructure financing gap. At the same time, institutional investors such as insurance companies and pension funds are trying to diversify their portfolios better and enhance their long-term asset-liability management with infrastructure assets. “Huge infrastructure demands and hungry institutional funds – link them.” (Heseltine 2012)

Australia and Canada have been the two leading countries in this respect. Australian pension funds have been pioneers in the field since the early 1990s, and their financial industry invented the label of ‘infrastructure as an asset class’. Canadian pension funds, the ‘maple revolutionaries’ (Economist 2012), are often held up as some of the world’s leading infrastructure investors, especially for their ‘Canadian model’ of direct investing.

This paper compares and contrasts the experience of pension funds in investing in infrastructure projects in Canada and Australia, looking at factors such as infrastructure policies, the pension system, investment strategies, asset allocation and governance of pension funds. In fact, the two countries have the highest asset allocation to infrastructure by pension funds (of roughly 5%) across the globe.

There are a number of similarities between the two countries, in particular a trust-based pension system, the absence of restrictive investment and solvency regulation, a mature PPP market and a relatively stable political environment. In line with international asset allocation trends, both countries have built up sizeable ‘alternative asset’ portfolios in recent years at the expense of public equities.

There are also some marked differences. Canada is largely abstaining from privatizations while Australia is considering further ‘asset recycling’ of public assets to finance new infrastructure projects. Canada has a well-functioning project bond market while Australia has not. The benefit systems are at the opposite ends of the spectrum with defined benefit (DB) in Canada and defined contribution (DC) in Australia. Canada’s pension plans are widely underfunded while Australia’s are growing fast.

Both countries have a highly fragmented pension scene but also a number of very large pension funds of global scale. A striking feature in both countries is the importance of the size of the pension schemes for investment in illiquid assets. The public attention is primarily on the behaviour of large funds but underneath there is little to no infrastructure investment activity by smaller funds.

Major ‘export articles’ from Australia are:

  • strong appetite for privatized assets by pensions funds and other institutional investors;
  • perhaps paradoxically, substantial infrastructure investing is possible in a DC pension system;
  • an experienced investment industry that has seen a few market cycles.

Other countries can take away from Canada:

  • outsourced investing with open-ended infrastructure funds, or ‘aligned asset managers’, at comparatively low cost (the ‘new Australian model’);
  • investment in illiquid assets by institutional investors is possible, even by underfunded pension plans;
  • the ‘Canadian model’ of direct infrastructure investing by pension funds (aiming at better control and lower cost of investment);
  • a well-working PPP market;
  • a robust project bond market.

Among the lessons learnt the hard way, and other issues encountered:

  • overly optimistic demand projections and overvaluation of assets;
  • risk allocation (e.g. demand and patronage risk) and risk management (e.g. liquidity and leverage

    risk);

  • volatility of listed infrastructure funds (the ‘old Australian model’);
  • governance and fee issues of infrastructure funds;
  • direct investing can be tricky, and requires adequate resources.

In terms of the actual performance figures, the data is still surprisingly poor. The experience, so far, appears mixed in both countries, and varies considerably across investors. Many projects and products more or less produce the expected income and return profile. However, there have been disappointments during and after the financial crisis, and these can weigh heavily in often highly concentrated portfolios. Circumstances are changing fast, and for most investments, it is simply too early to say.

Important lessons can be learnt not only by investors but also policy makers. Political and regulatory stability are paramount for long term investment strategies. From the outset, infrastructure has been a global asset class with surprisingly little home bias. Canada in particular faces the paradox of a mature PPP market at home while the large pension funds invest most of their equity capital abroad.

The comparatively loose investment and pensions regulation (under the prudent person principles) allows Canadian and Australian pension funds to invest in illiquid assets to a higher degree than in most other countries.

Governments are (sometimes desperately) trying to divert private investment flows into domestic infrastructure. At the same time, investors often bemoan the lack of a consistent project pipeline at home, and the shortage of suitable investment opportunities in general. There are obviously still intermediation issues to work on for both governments and the financial industry.

The combination of (perceived) supply side constraints and a rush of new capital committed to infrastructure, from all sorts of players on a global scale, may again lead to an unhealthy overvaluation of assets with subsequent disappointments.

Finally, a lot of lip service is being paid to ‘sustainable investing’ or similar themes in the investment community. Infrastructure could, almost by definition, be a core ingredient of any ‘long term investment’ policies by pension funds, and also play a major role, for example, in climate change mitigation and adaptation. However, the link is not very clear, and much more work needs to be done on these concepts and in practice.