Investment infrastructure is discussed broadly in the pension fund industry. But how can you check for your fund’s readiness to invest in infrastructure? Is this form of investment suitable for your fund? Malizole Mdlekeza, Pensions & Investments Actuary, Managing Director of MDM Actuaries and Chairman of the Actuarial Society of South Africa’s Alternative Investments Forum, walks us through a high-level decision-making process.
Infrastructure investment for pension funds is widely spoken about these days, but given the uniqueness of South Africa’s pension fund industry, how, realistically, can pension funds invest? Is investing in infrastructure suitable for your fund at all?
Currently, South Africa has just under 5 000 FSCA registered retirement funds, and a total pension industry size sitting upwards of R4.6-trillion.
South Africa has various categories of funds, such as defined benefit funds (where the pensions paid depend on the number of years a member has contributed to a fund, as well as their level of earnings or salary near retirement); and defined contribution funds, where the benefits or pensions paid at retirement vary and depend heavily on variable factors such as investment returns over time. Defined contribution funds can be further subdivided into the pension vs. provident fund sub-categories, and one can further sub-categorize funds into standalone vs umbrella funds, for example.
While each pension fund is unique, and proper actuarial and investment advisory and modeling is needed before making suitable and appropriate investment decisions, there are (at least) five high-level criteria that trustees need to consider before investing in infrastructure:
1. Appetite to invest
Trustees need to assess, independently, whether they want to or are ready to more directly and consciously invest in infrastructure before anything else. We do not operate in a prescribed assets environment currently, so the choice to invest ultimately remains with the trustees.
Returns on well-structured and operational unlisted infrastructure assets, for example, tend to be more stable over time than investment into listed equities (the stock market) – in part because such infrastructure investments are less affected by market fluctuations and sentiment, among other things. Unlisted infrastructure investments may be more attractive if a fund is concerned about diversification and volatility for example.
So, the first thing funds need to do is decide whether this is something that they are interested in exploring or not.
2. Pension Fund Structure
Each pension fund is unique, so pension funds need to assess whether their type, total fund size, size relative to liabilities, cash flow patterns and liquidity requirements (among other things) are suitable for each type of infrastructure investment opportunity or vehicle. There is no one size fits all infrastructure investment for pension funds.
Many South African funds are in fact already likely to be invested in infrastructure in some way, shape or form (e.g, through JSE listed bonds such as SANRAL bonds), but broader forms of investment should also be considered.
Typically, defined contribution funds have a greater need for day-to-day availability of underlying asset prices (price discovery) as well as liquidity, for example. This tends to mean that, all else being equal, listed infrastructure investment forms or vehicles may be more relevant for defined contribution funds. It is not to say unlisted infrastructure investments are not suitable for such funds however – funds can still invest after proper investment advisory and structuring.
3. Financial Returns
Pension funds should provide good financial returns for their members – and this is a central consideration.
While returns do vary over different time periods, the JSE SWIX 40 Index (a common South African equity index/benchmark) has had yearly returns ranging from CPI -2% to CPI + 3% per annum over the past few years (depending on the specific time period). There are examples of infrastructure focused investment funds in South Africa that target returns ranging from CPI + 4% all the way to CPI + 10%, for example. Return targets or benchmarks can be higher or lower than this still (depending on a specific fund’s mandate, risk profile and the underlying mix of investments), but one would generally expect the returns on well-structured infrastructure investments, before fees, to be consistently above CPI inflation. In other words, infrastructure investments in the long run, can be expected to outperform CPI inflation.
Returns are also generally more stable over time (compared to investing in listed equities), as the unlisted versions of infrastructure investment are not subject to the day-to-day fluctuations of listed stock markets.
Typically, infrastructure is a long-term asset class, not a short-term venture, but there (as always) are caveats.
How risky is investing in infrastructure?
Generally, investment into the early stages of infrastructure (greenfield investment) is relatively risky for the average pension fund, and it is typically better for pension funds to invest in infrastructure once it is in its operational phase (brownfield investment).
Investing in infrastructure also typically carries unique and perhaps additional risks. These may include construction risk, interest rate risk and funding risk, for example. These need to be assessed and managed/mitigated appropriately.
Proper investment structuring (for example, the inclusion of government guarantees) can help to mitigate some of these risks.
5. Social impact
In today’s environment, social impact and social responsibility are important factors for pension funds to consider in their investment decisions, as we move into a society where the impact of investments is more consciously monitored and measured.
Investing in infrastructure can help a fund better meet its social investment objectives in ways that other “non-infrastructure” assets may or may not be able to. Certain types of infrastructure may be more suitable to certain types of impact related goals. The UN, for example, has come up with a set of 17 sustainable development goals, called the UN SDGs. Investment into renewable energy projects, for example, may help meet SDG 7 (affordable and clean energy), and investment into hospitals and schools may help meet SDGs 3 and 4 respectively (good health & well-being, and quality education), among others.
With so much talk around investing in infrastructure these days, it can be difficult to know how to proceed. This high-level list, backed up by thorough specialised actuarial & investment modelling and ongoing due diligence, will ensure that pension funds are better prepared when it comes to making this decision.
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