Tuesday, February 10, 2015

Focus on Emerging Market Infrastructure?

Max Townsend, a student at the Queen’s School of Business, wrote a comment for the Globe and Mail, Canada’s pension plans should focus on emerging-market infrastructure:
When the World Bank and International Monetary Fund held joint annual meetings last fall, the gathering focused on a vision for the global economy moving forward. As a third-year Queen’s University Commerce student, attending the meetings as a member of the Young Diplomats of Canada, I came away from the meeting with two key conclusions.

First, Canada – and all developed countries – has a bigger role than ever to play in shaping the global agenda for development. Second, infrastructure should be viewed as a key investment opportunity in developing nations, with significant upside for all involved parties. And Canada’s pension plans could play an important role.

Four of Canada’s largest pension funds, including the $234-billion Canada Pension Plan Investment Board (CPPIB), manage multibillion-dollar infrastructure portfolios, with the CPPIB’s amounting to approximately $13.5-billion. The recent financial crisis and subsequent turmoil in global stock markets, has led many funds to look for stable, long-term assets. The demand for these assets is much greater than the supply in the developed world, forcing pension plans to look elsewhere. This comes just as many international organizations, such as the World Bank, have been pushing for more private sector investment in emerging market infrastructure.

Private investment in foreign infrastructure projects is a long-term solution to many of the issues facing developing countries and could lead to less dependency on foreign aid. In 2013, Canada contributed $5-billion in foreign aid through targeted projects managed by the Department of Foreign Affairs, Trade and Development (DFATD). Using private money, particularly from pension funds, to make some of these infrastructure investments could lessen the reliance on DFATD funding and increase opportunities for other types of investment for the developing countries.

For example, the infrastructure assets most targeted by large Canadian pension plans include toll roads, airports, water and sewage networks, as well as telecom towers. Those are many of the same projects that developing countries need. When a nation emphasizes the creation of infrastructure such as passable roads, reliable electricity and improved water supplies, its business climate becomes more appealing for local and international investors.

While historically there has been reluctance to invest in infrastructure throughout the developing world due to a lack of strong political and legal institutions, the development community has emphasized change. It understands the concerns of the private sector, and has committed to finding ways to make the developing markets less risky and more attractive to institutional investors. Only by doing this will the development community be able to achieve lofty economic growth and prosperity goals.

When investing in the developing world, it is vital that investors and multilateral organizations gauge the associated risks. Many of the targeted countries are rife with geopolitical challenges that could quickly destabilize a project. A better understanding of the risks and rewards for private sector infrastructure investment in developing nations could lead to new solutions for many of Canada’s large pension plans, while reducing the foreign aid bill that is funded by taxpayers. Although economic growth does not guarantee an increase in human well-being, it is certainly regarded as a key driving force to improving lives.

There is more at stake than just development for less fortunate countries. Canada too benefits from this kind of investment, through potentially better returns for our pension plans and less taxpayer money taken up with foreign aid.

As a young Canadian, the fall meetings opened my eyes to the countless alternatives that should be considered when facing the systemic issues experienced by many developing nations. While investing in infrastructure is but one option, it gives me hope for the future of both Canada’s development agenda, as well as the success of our global neighbours in this increasingly interconnected world.
First, let me commend Max Townsend for writing an excellent article on infrastructure and the role our large Canadian pension funds are playing investing in infrastructure all around the world.

As I recently commented, Canada's big pensions have been busy snapping up primarily U.S. real estate and some are even venturing into Europe now. This, despite the fall in the loonie, signals they see better growth prospects outside of Canada, with the U.S. leading the way to a possible global economic recovery (that's the best scenario they're all hoping for).

Townsend's article, however, makes some assertions I'm a bit uncomfortable with. In particular, he states that "investment in foreign infrastructure projects is a long-term solution to many of the issues facing developing countries and could lead to less dependency on foreign aid." While this may be true, private-public partnerships in infrastructure (PPPs) are no substitute for foreign aid which the world's poorest countries desperately rely on.

Also, as Townsend states, these private investments in infrastructure are driven entirely by profit. This isn't foreign aid or charity. These large Canadian pensions are looking to invest in safe, stable long-term assets which can yield a rate-of-return on assets to match their long-dated liabilities.

But as the article mentions, there are plenty of risks in these very long-term, illiquid investments too. Currency risk, political risk, regulatory risk, corruption and illiquidity risk. These risks are especially prevalent when investing in developing nations but they are also present when investing in developed nations.

In my comment on Greece's do-or-die moment, I stated the following:
Greece's new left-wing government will cancel plans to sell the state natural gas utility and is firmly opposed to a Canadian gold mine that is among the biggest foreign investment projects in the country, the energy minister told Reuters on Friday.
If I was André Bourbonnais, PSP Investments' new CEO, I'd be very concerned with these actions as they demonstrate a flagrant disregard for public-private partnership deals and could significantly jeopardize PSP's stake in Athens' airport.

I asked a friend of mine who is an expert in infrastructure to share his thoughts. I specifically asked him if Syriza can renege on deals struck by the previous government and jeopardize PSP's take in Athens airport. He replied:
"Sure it can. Syriza can pretty much do whatever it wants. But there will be consequences to all these actions and Greece will go the way of Pakistan which pissed off foreign investors a long time ago and hasn't been able to strike any major PPP deal in the last 15 years."
He added: "Varoufakis (Greece's new finance minister) is being used as a political pawn. He doesn't realize it yet but his head will be chopped and Syriza will use him as the fall guy when the shit hits the fan -- and the shit will hit the fan the way these guys are governing the country."
I don't share my friend's views on Varoufakis and think even though the Varometer is rising in Europe, cooler heads will prevail.

But on infrastructure and the consequences of scrapping PPP deals that were put in place, my friend is absolutely right, if the newly elected Greek government reneges on previous deals, nobody will ever invest in any major infrastructure project there (not that they will invest now with all the political uncertainty).

This is one reason why Canada's large pension funds have traditionally invested in developed countries like Britain where they own most of their infrastructure. The recent deal the Caisse struck with Quebec's government to handle the province's infrastructure investments paves the way for other Canadian funds to strike similar deals, provided the governance is right.

Sure, there are tremendous opportunities in emerging market infrastructure and some funds like AIMCo have successfully invested in Chilean highways and other projects, but for the most part, the focus remains on developed markets where funds can better gauge long-term political risks (in my opinion, the biggest risk to these infrastructure investments).

There are other risks I'm worried about, including global deflation spreading throughout the world. Right now, my focus is more on China than Grexit because inflation there just plunged to 0.8% in January, its lowest level for more than five years, fuelling fears the world’s second-largest economy is on the brink of a deflationary spiral.

A severe deflationary shock in China will cap prices of goods and services there and potentially explode if we see another eurozone crisis, exacerbating deflationary headwinds that are now threatening to come to America, cutting its decent economic recovery short.

This is why U.S. policymakers are putting the pressure on eurozone's leaders to find a long-term solution to the ongoing crisis. They see what's going on in China and fear the worst. This is also why I'm not buying the consensus view that the Fed is on the cusp of raising rates.  

A friend of mine who trades currencies told me this morning "there's a currency war going on and it's likely we'll see the mighty greenback surging another 10% relative to other currencies before we get another Plaza Accord." He added: "The decline in the euro and oil prices will provide much needed relief for the ailing eurozone but it's not enough to deal with its long-term structural problems."

I agree, it won't be enough which is why my biggest fear remains that deflation will continue pounding most pensions taking on too much illiquidity risk. Hopefully I'm wrong and the U.S. will once again save the global economy, but I'm in Gundlach's camp that this time is really different.

Privcap provides a clip of a panel of experts from Pembani Remgro, IFC Global Infrastructure, and NSG Capital talking about their approaches to putting private equity capital to work in emerging market infrastructure.

Below, German Chancellor Angela Merkel and U.S. President Barack Obama comment on Greece after a meeting at the White House on Monday (h/t, Greek Reporter).

They're likely going to come up with some short-term deal on Wednesday at the Eurogroup meeting but too many people are still too complacent on contagion risks if a deal isn't struck (read Anatole Kaletsky's latest, Greece is playing to lose). We shall see but as I mentioned above, I'm a lot more worried about China and global deflation than Grexit right now.

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