James Bevan: The coming infrastructure finance boom

Richard Williams and I discussed the challenges that investors face in a climate of low yields. Europe’s pension and insurance industries face what could amount to an existential crisis if European yields remain as low as the ECB would apparently like them to and the institutions don’t change their investment strategies.

Financial markets are seemingly not overly concerned perhaps because central banks are busy buying assets, and if asset prices rise continuously, even as savers draw on capital, the problem is in effect met from rising capital values. That can be seen as making pension funds, and other investor groups, that are dependent on spending realised capital gains participants in a sort of giant Ponzi Scheme.

For sure some people will be able to get out in time. But in the cold light of day, few in the institutional funds and savings industries can really believe that they can afford to run themselves on the assumption that asset prices only ever rise, whatever central bankers may seem or seek to promise.

Instead these long-term investors will have to find something that provides an acceptable yield on a risk adjusted basis. However, this stretch for yield may well push such investors yet further along the risk curve, for better or worse, not least because they will be buying assets that many already consider to be expensively priced.

It will also likely push them down the liquidity curve into less liquid investments and into physical assets, hence the surge in interest in commercial property.

We can expect that the next area that will come into focus will be infrastructure project financing, and this is already much favoured by many North American institutions. It therefore seems highly likely that we will shortly see significant flows from European long-term investors into the infrastructure and project finance sectors.

This may be fine as it stands, but compression of yields will lead to less attractive risk-adjusted returns, and the tide of ‘private’ money in the opportunities may be augmented by public finance initiatives too. This would likely happen if global economic growth underwhelms, or simply disappoints, governments and their electorates over the next six to twelve months. Many lead indicators suggest that this is a risk, with low activity levels exacerbated by a combination of world trade price deflation and rising savings rates which serve to sap spending growth.

It’s come as something of a shock to some commentators, and investors, that this environment of sluggish growth and deflation risks has occurred despite the massive ‘money printing’ efforts of many central banks. Although this shouldn’t surprise really. It would seem that central banks’ own confidence in their abilities to alter the fate of their real economies is beginning to fade as they re-learn the lessons of the 1960s and 1970s: central banks can only seek to affect nominal not real variables. Meanwhile, there is increasing evidence that global productivity growth has slowed on an average basis over the last ten to fifteen years. This problem is at last starting to be recognised.

Against such a background, we can reasonably expect governments to want to become yet more directly interventionist within the real sectors of economies. We can therefore expect that over the next few years, more public sector money will be directed at roads, railways, telecoms systems and (we can hope) education facilities.

The combination of investor interest, predicated on the need for higher returns in a climate of generally low yield and low growth, recognition that central banks alone cannot drive growth through monetary policies, however unconventional, and governments taking increasing interest in fomenting recovery, suggests that we should expect a significant boom in infrastructure project finance, public-private sector joint finance initiatives and some actual building and construction work as well.

Some of this activity may help to raise global productivity growth. Alas, the history of public sector initiatives and capital resource allocations in boom periods suggest that, even more than usual, investors need to be cautious, alive to the risks and not just the potential returns. We’ll be focused on the opportunities for sure – but also wary of the risks, particularly where weight of fund flows may swamp possible returns, and/or make businesses, and those that need the capital, less disciplined than we would like.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla