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Are Institutional Investors the Answer for Long-Term Development Financing?

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Are Institutional Investors the Answer for Long-Term Development Financing? Development Co-operation Report 2014 Mobilising Resources for Sustainable Development © OECD 2014 PART I Chapter 6 Are institutional investors the answer for long-term development financing? by Raffaele Della Croce, Directorate for Financial and Enterprise Affairs,1 OECD Developing countries need long-term investors to help finance activities that support sustainable growth such as infrastructure, including low-carbon infrastructure. With USD 83.2 trillion in assets in 2012 in OECD countries alone, institutional investors – pension funds, insurers and sovereign wealth funds – represent a potentially major source of long-term financing for developing countries. Despite the recent financial crisis, the prospect for future growth for institutional investors is unabated, especially in developing countries. But although interest is growing, the overall level of institutional investment in infrastructure remains modest and major barriers to investment still exist. Greater growth will depend on policy and structural reforms to create a more favourable investment climate, build private sector confidence and ensure that global savings are channelled into productive and sustainable investments. This chapter also includes an opinion piece on long-term investment by Sony Kapoor, Managing Director of Re-Define, on promoting long-term investment in developing country infrastructure. 79 I.6. ARE INSTITUTIONAL INVESTORS THE ANSWER FOR LONG-TERM DEVELOPMENT FINANCING? Long-term finance plays a pivotal role in fulfilling physical investment needs across all sectors of the economy (OECD, 2013c). It is also essential for the development of small and medium-sized enterprises, especially young, innovative, high-growth firms. Addressing the challenge of climate change and other pressures on the environment will require long-term investments in renewable energy and low-carbon technologies (G20/OECD, 2013). However, many countries find it hard to secure long-term investment in these sectors. For example, the OECD estimates the total requirement for global infrastructure investment for transport; electricity generation, transmission and distribution; water; and telecommunications to be around USD 71 trillion by 2030 – about 3.5% of global gross domestic product (GDP) over the same period (Schieb, 2007).2 Achieving a low-carbon energy sector globally will require an additional cumulative investment of USD 36 trillion by 2050, including USD 7.35 trillion in the power sector, of which USD 1.2 trillion would be needed in the People’s Republic of China (IEA, 2012; and see Box 6.2). Achieving a low-carbon global energy sector will require an additional cumulative investment of USD 36 trillion by 2050. Such levels of investment cannot be financed by traditional sources of public finance alone. The impact of the financial crisis has exacerbated the situation further, reducing the scope for public investment in infrastructure within government budgets. The result has been a widespread recognition of a significant infrastructure gap and the need for greater recourse to private sector finance (OECD, 2013c). The credit crisis has weakened the capacity of traditional providers of long-term finance – banks – to provide long-term financing. Can institutional investors (Box 6.1) fill the gap? They offer a potentially large and diversified source of long-term financing for physical and intangible investment needs across all sectors in developing countries. This is specifically the case for key drivers of growth, competitiveness and employment, such as infrastructure, company equipment, education and skills, research and development, and new technology. Institutional investors play a key role in channelling savings into productive long-term investments, especially those that can be difficult to finance because they are “illiquid”.3 Given the low interest rate environment and volatile stock markets of recent years, institutional investors are increasingly looking for new sources of long-term, inflation-protected returns. Investments in real, productive assets such as infrastructure could potentially provide the type of income these investors require (OECD, 2013c). This chapter explores the current trends and future scope for institutional investment in emerging economies in particular, and asks what policy support frameworks would be required to tap this promising source of finance. 80 DEVELOPMENT CO-OPERATION REPORT 2014 © OECD 2014 I.6. ARE INSTITUTIONAL INVESTORS THE ANSWER FOR LONG-TERM DEVELOPMENT FINANCING? Box 6.1. Who are the institutional investors and how do they work? Traditionally, this heterogeneous group of public and private investors – in particular, pension funds, life insurers and sovereign wealth funds – has been seen as a source of long-term capital with investment portfolios built around the two main asset classes – bonds and equities – and an investment horizon tied to the often long-term nature of their liabilities. Over the last decade, institutional investors have been looking for new sources of long-term, inflation-protected returns. Asset allocation trends observed over recent years show a gradual globalisation of portfolios with an increased interest in emerging markets and diversification in new asset classes. However, although growing rapidly, investment in infrastructure is still limited, representing around 1% of total assets on average across the OECD (OECD, 2013a). Pension funds start collecting contributions when individuals enter the workforce and may only start paying benefits 30 to 40 years later with the assets accumulated. With USD 22 trillion in assets held by autonomous pension funds in OECD countries and annual contribution in-flows of around USD 1 trillion, pension funds could be key sources of capital for development. Public pension reserve funds are set up by governments or social security institutions to contribute to the financing of the relevant pay-as-you-go pension plans. Some of the world’s largest public pension reserve funds (including the pension plans for California’s state teachers and public employees) actively target infrastructure projects in developing countries. Life insurance companies also tend to have long-term liabilities, especially as major providers of annuities and similar retirement products. Some of the major insurance companies around the world have made commitments to green infrastructure investment. Mutual funds offer a simple way for people to invest their money. A mutual fund – most often consisting of a mixture of stocks, bonds, cash and other securities – pools the assets of multiple investors. The total amount is invested by a fund manager into a variety of holdings. Investing in such a wide array of stocks and bonds would not be possible for the average investor without the help of a mutual fund. Sovereign wealth funds are special-purpose investment funds or arrangements owned by a central government whose purpose is either to ensure that a country’s resources are preserved for future generations, or to stabilise government fiscal and/or foreign exchange revenues and macroeconomic aggregates. Sovereign wealth funds and public pension reserve funds are becoming major players in international financial markets. Assets under management by such funds have been growing rapidly and in January 2014 accounted for more than USD 6 trillion according to the Sovereign Fund Institute. Source: G20/OECD (2013), “G20/OECD High-Level Principles of Long-Term Investment Financing by Institutional Investors”, OECD, Paris, www.oecd.org/daf/fin/private-pensions/G20-OECD-Principles-LTI-Financing.pdf; OECD (2013c), TheRoleofBanks, Equity Markets and Institutional Investors in Long-Term Financing for Growth and Development, Report for G20 Leaders, OECD, Paris, www.oecd.org/daf/fin/private-pensions/G20reportLTFinancingForGrowthRussianPresidency2013.pdf. Institutional investment is on the rise Institutional investors – particularly pension funds, insurance companies and mutual funds – are increasingly important players in financial markets. In OECD countries alone, these institutions held USD 83.2 trillion in assets in 2012 (Figure 6.1). The annual inflow of new funds is also substantial. For instance, pension funds collected about USD 1 trillion in new contributions in 2012. DEVELOPMENT CO-OPERATION REPORT 2014 © OECD 2014 81 I.6. ARE INSTITUTIONAL INVESTORS THE ANSWER FOR LONG-TERM DEVELOPMENT FINANCING? Figure 6.1. Total assets by type of institutional investor in the OECD, 2001-12 USD trillion Investment funds Insurance companies Pension funds Public pension reserve funds1 Other2 USD trillion $30.0 tn 30 25 $24.5 tn $21.8 tn 20 12 10 $5.0 tn 5 $1.9 tn 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Notes: Book reserves are not included in this figure. Pension funds and insurance companies’ assets include assets invested in mutual funds, which may be also counted in investment funds. 1. Data include Australia’s Future Fund, Belgium’s Zilverfonds (2008-12), Canada’s Pension Plan Investment Board, Chile’s Pension Reserve Fund (2010-12), France’s Pension Reserve Fund (2003-12), Ireland’s National Pensions Reserve Fund, Japan’s Government Pension Investment Fund, Korea’s National Pension Service (OECD estimate for 2012), New Zealand’s Superannuation Fund, Norway’s Government Pension Fund, Poland’s Demographic Reserve Fund, Portugal’s Social Security Financial Stabilisation Fund, Spain’s Social Security Reserve Fund, Sweden’s AP1-AP4 and AP6, the United States’ Social Security Trust Fund. 2. Other
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