In-Sorcerer: The Magic of Insourcing Infrastructure Investments

Ashby Monk

Helen Thomas of the FT has some bad news for asset managers trying to woo pension assets for their infrastructure funds. She reports that these big funds are bypassing traditional fund managers and investing in infrastructure directly.

“Big pension funds are increasingly looking to invest directly in infrastructure assets…While pension fund managers like infrastructure assets because their extended lifetime helps balance the funds’ long-dated liabilities, they have traditionally relied on investing through third-party funds. However, some of Canada’s largest pension plans, including the CPP Investment Board and Ontario Teachers, have established reputations as canny investors in infrastructure. Now others, including AIMCo and Quebec’s Caisse de Depot, are increasingly using in-house teams to lead their infrastructure investment. Calpers, the largest US pension fund, is also ramping up its efforts…”

For those totally out of the loop, infrastructure assets break down into two broad categories: economic and social. The former typically refers to transport, utilities, or communication investments, while the latter refers to schools, hospitals, prisons or even parks. Generically, pension funds are well suited for these types of investments, as the time horizons and steady cash flows match up nicely with the funds’ long-term pension liabilities. However, pension funds have traditionally (for the most part) relied on asset managers to help them get exposure to this alternative asset class. Not any more apparently.

discussion I recently had with a major pension fund executive on this topic sums up the rationale pretty tightly:

“Why pay all these fund fees if this is an asset we want to hold in our portfolio for the long term?”

Agree to agree. And this is what I had to say in October about this topic and SWFs:

“…a SWF investing in a private asset manager that, in turn, invests in infrastructure just seems off to me. Feel free to disabuse me of this position, but won’t the SWF be giving up its main competitive advantages by doing this (i.e. scale and time horizon)? Again, my view is that the scale and time horizon of SWFs makes them (in theory) world beaters in this specific asset class. Who can bring this amount of money over this time horizon to a single infrastructure project? I’m pretty sure the answer to that question is ‘nobody’. I don’t think…and I could be wrong here…that the private sector asset managers can compete on the same level; the private funds are too small and the duration of the infrastructure assets too long (and the demands of the LPs too myopic).”

I think the same holds true for large, public pension funds. And, apparently, I’m not the only one who has noticed this incoherence. Here’s how George Inderst of the OECD explains the rationale for pensions’ interest in in-sourcing infrastructure:

“Paradoxically, pension funds often find the lifespan of the infrastructure vehicle offered too short for their needs. There is a maturity mismatch between the typical length of private equity-type of funds (typically 10 years) with the liabilities of pension plans (often much longer). Trustees do not like the idea of selling assets that they might have bought for a long-term, steady, inflation-linked income stream. Providers prefer to realize investments and set up successor funds.”

So in-sourcing infrastructure is a good idea, right? Yes. Well, sort of. Actually, plenty can go wrong, so I’ll be the first and the last to say this: in-sourcing has to be done right or not done at all. There are innumerable opportunities to screw up. For more details on the pitfalls, read here.

This means the potential “in-sorcerer” – which I define as any asset owner that seeks to make asset management fees or agency costs magically disappear through a program of in-sourcing (©!) – has to be extremely proactive about organizational design, governance and talent. But, given the right circumstances, that’s totally do-able. All in all, I think this is a positive development. The more money we can profitably direct into infrastructure assets for the long term, the better!

5 Responses to “In-Sorcerer: The Magic of Insourcing Infrastructure Investments”

  1. 1 Frank Ashe January 4, 2011 at 2:03 pm

    A better model than in-sourcing is for SWFs and large pension funds to pool their efforts and set up their own, jointly owned asset manager to provide the services needed for investing in infrastructure projects. This also more easily allows diversification across projects,

  1. 1 Guest Blog: Infrastructure Sensitivities and SWFs « Oxford SWF Project Trackback on February 25, 2011 at 6:02 am
  2. 2 SWFs ♥ Infrastructure « Oxford SWF Project Trackback on March 9, 2011 at 10:45 am
  3. 3 It’s Expensive To Save Money « Oxford SWF Project Trackback on August 1, 2011 at 11:31 am

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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