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Pension Fund Investment in Infrastructure: a Resource Paper

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Pension Fund Investment in Infrastructure: a Resource Paper - Occasional Paper Series - No.3 December, 2008 Pension Fund Investment in Infrastructure: A Resource Paper By Larry W. Beeferman Pensions and Capital Stewardship Project Labor and Worklife Program Harvard Law School Contents Abstract............................................................................ 1 Introduction...................................................................... 2 Section 1: Risk, Reward, and Other Financial Considerations A. Infrastructure: defi nitions………….…………….…... 5 B. Why infrastructure investments may be attractive to pension funds.................................... 7 C. The fi nancial rewards and risks of investments in individual infrastructure facilities…………….. 8 D. Where infrastructure investments fi t in the fund portfolio…................................................. 15 E. Types of investment vehicles……………….............. 18 F. Financial performance…………………………………. 23 G. Fees and other charges………………………………. 29 Section 2: Labor Implications and Responses A. Potential impacts………..……………………………... 32 B. Contractual and legislative responses…………….. 35 C. Pension fund responses.…..……………………….... 40 Conclusions…………………………………….................. 50 Endnotes…..…………………………………….................. 56 Occasional Papers | December 2008 Pension Fund Investment in Infrastructure: A Resource Paper By Larry W. Beeferman* Abstract What is termed “infrastructure” appears to offer pension funds opportunities for investment that might yield substantial and predictable returns matching their long-term liabilities. But there are diverse ways by which infrastructure is defi ned and an increasing number and variety of facilities or services are being lumped under that term. Infrastructure appears to be attractive as a means for diversifying pension fund investment portfolios, but it does not readily fi t within a distinct asset class. This complicates the task of assessing how it diversifi es a fund’s portfolio and helps achieve its fi nancial objectives. Whatever the infrastructure investment vehicle, its profi le of reward and risk ultimately derives from those of the underlying individual infrastructure project investments. At the project level many factors shape the profi le. There are an increasing range and variety of investment vehicles from mutual fund-like public traded vehicles to private equity-like limited partnerships to direct investment. They differ greatly in terms of the demands they make on pension funds’ organizational capacity and resources and decision-making and oversight capabilities. Historical data on returns and risks of investment vehicles is limited and constrained by the largely commercial nature of the sources of that data. There are few scholarly studies. Those studies suggest that claims about long- term, relatively stable and not insubstantial returns have some merit, but much more needs to be done to substantiate those claims. Fees charged for investment through various vehicles vary widely from mutual fund-like to private-equity fund-like fees. Particularly with regard to the latter there are concerns about whether such fees are excessive and, as a related matter, whether there are serious confl icts of interest in how the vehicles are managed. Investments in infrastructure, like other kinds of investments, potentially pose concerns about the job impacts and labor practices of both the companies that are the object of investment and the public entities, the privatization of whose facilities or operations provides the occasion for private investment. These concerns are a special source of apprehension for public sector pension funds whose members might be affected. Wholly apart from action pension funds might take, political debate over privatization has resulted in the imposition of both process and substantive labor-related requirements by legislative bodies or executive offi cials either as a matter of broad policy or decision-making in particular contexts. While some may argue that such action moots out any need for involvement by pension funds, a number of funds have concluded that they as prospective owners of privatized facilities need to address job impacts and labor practices and have formulated policies to do so. A number of those policies relate to how the fund should take cognizance of potential loss of or harm to public sector jobs; others pertain to the workplace issues at privatized facilities. Generally speaking, these policies avoid hard and fast rules in favor of provisions that encourage or incentivize managers of investment vehicles to take serious enough account of job and labor issues. Correspondingly, they aim to spur pension fund decision-makers to seriously bear in mind how those managers have acted without compelling those decision makers to not invest with or disinvest from managers whose behavior falls short. Such fl exibility is seen as a means for accommodating the requirements of fi duciary duty. *Director, Pensions and Capital Stewardship Project, Labor and Worklife Program, Harvard Law School -1- Occasional Papers | December 2008 Introduction Infrastructure has drawn increasing attention from pension funds as a potential alternative to traditional investment classes.1 Funds are attracted by the idea that they might earn higher or more stable returns, diversify their portfolios, and fi nd better matches for their long-term liabilities. Driving fund interest is a mounting global demand for new infrastructure, as well as for the expansion and repair of existing facilities. Among the new opportunities for private investment are those in what have traditionally been public ventures, such as roads, bridges, tunnels, and water and waste-water plants.2 Although the defi nitions of what is considered a public venture vary, the options available to investors have expanded in recent years to encompass a wide range of regulated services and facilities that are predominantly privately owned, including energy-, utility-, and communications-related services as well as hospitals, schools, parking facilities, and even lotteries. This paper pays special attention to traditional public ventures that have been the focus of investment by public-sector pension funds. We do so because of the labor-related issues they involve, which may be of keen interest to public-sector plan members.3 For that reason we offer the following observations: Infrastructure investment opportunities linked to the privatization of public services have arisen in part due to the decades-long dominance, most pronounced in the United States, of political leaders and other market-oriented advocates who contend that roads, bridges, and other infrastructure can be run more effi ciently by private owners or operators. This view remains politically divisive and highly contentious, with critics attacking it as avaricious privatization and proponents endorsing it with a softer, less threatening term of “public- private partnerships.” Advocates typically invoke the virtues of market forces to deal with the public sector’s failure to keep up with infrastructure requirements, while opponents stress the continued need for public-sector solutions to the delivery of public goods and services. The pro-privatization view has gained suffi cient support to spur a wide range of new investment possibilities in the United States and abroad. -2- Occasional Papers | December 2008 Private-sector infrastructure investment in traditionally public ventures also is being propelled by widespread resistance to tax increases, again especially pronounced in the United States after decades of political focus on the topic. More generally, public offi cials who do not want to take responsibility for raising taxes or user fees to pay for new schools or road repairs have been turning to private investors to help fi ll in the gap.4 One issue not extensively addressed in the debate is how private infrastructure investment nonetheless alters the taxes or fees citizens (or users) must pay. Where traditionally public ventures are involved, even if privatization proponents turn out to be correct about the greater effi ciency of that approach, someone still must pay to build and run new public facilities or modernize existing ones. Historically, such funding has involved some combination of tax revenue, public debt, and user fees. The mix may change when private investors step in, which could mean different people pay. For example, privatized highways that charge tolls shift the cost to those who use that road and away from all taxpayers (or from all drivers if gas taxes had been used). Such shifts raise often-unexamined questions about what in fact changes for taxpayers. Some private-sector solutions even involve deferred or hidden public subsidies, such as “shadow tolls,” that have been developed to ensure that toll road operators’ profi t goals are met.5 Thus private investment may appear to remove infrastructure fi nancing off public balance sheets and off the backs of politicians, even as citizens continue to pay in one form or another. Such investments also can raise troubling questions of equal access for lower-income taxpayers and whether private investment may lead to de facto privatization of the public service itself – even one that remains at least partially subsidized by all taxpayers. Private investment in public services can raise more troublesome questions when pension funds serve as a source of capital. Public pension funds in particular may face diffi cult choices if they invest in privatization efforts that may cause harm to plan members
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