Build it and they will fund

Business World
Introspective

Ever since President Aquino announced his administration's PPP thrust during the first State of the Nation Address, a lot of thinking has gone into creating an infrastructure fund for the Philippines. The premise behind creating such a fund is that the domestic financial market is failing to provide the right sort of financing that infrastructure projects need, i.e., long-term (think 25 years), fixed-rate and peso-denominated. Hence, investors end up with increased risks associated with rolling over short-term debts and/or unfavorable currency movements that raise their cost of capital and ultimately increase the cost of infrastructure investments.

While the premise was defensible, it was at the same time difficult to ignore criticisms raised against it in light of overwhelming interest among private sector players to mobilize their huge sums of idle money (P1.7 trillion parked in the BSP's Special Deposit Account) for infrastructure investments as well as the overtures of development partners pledging financial support of varying maturity, interest and currency profiles.

Moreover, the design and structure of the national government-driven proposed fund, which was envisioned to be catalytic yet commercially oriented, fell short of capturing the full support of either government or international financial institutions tapped to contribute to it. Many of these privately voiced the view that they can generate superior returns by directly investing in projects of their own choosing rather than in a pooled fund to be managed by a new, untested institution. Thus, despite much ado, the infrastructure fund to date remains on the drawing board.

While the nationally directed infrastructure fund continues to undergo tweaking, one of the chosen funders, the public pension fund Government Service Insurance System (GSIS), has announced a plan to create its own infrastructure fund. Unlike earlier versions with their confusing mandates of balancing developmental and commercial objectives, the GSIS-led fund is designed primarily to meet GSIS goals, i.e., diversification of fund assets, better matching of assets and liabilities as well as potentially higher returns.

Indeed, pension funds around the world have increasingly been attracted to infrastructure assets on the assumption and some evidence that these assets have a risk-return profile falling in between bonds and equities, i.e., they offer higher risk/returns vs. bonds while lower risk/returns vs. equity investments. Hence, from mere buying of listed stocks of companies in the infrastructure sector, pension funds have, depending on their individual risk appetite (which is also a function of their demographic profiles), moved into investing in listed or unlisted infrastructure funds managed by third parties, buying portions of infrastructure assets directly, or in the case of one Canadian pension fund, setting up an investment arm dedicated to finding suitable infrastructure assets. Many have opted to invest not only domestically but internationally. Increasingly too, pension funds are not only looking at mature assets with stable cash flows but a recent The Economist article (from which the title of this piece is borrowed) reported on a plan in the UK for pensions to invest in higher-risk greenfield assets.

This appears to be the thinking behind the GSIS infrastructure fund as well. In light of the Aquino administration's ongoing efforts to develop a pipeline of PPP projects, there are significant opportunities for an entity that takes a long view of investment returns to participate in the program. More so if the entity is well-placed to handle political and regulatory risks that investors typically associate with infrastructure projects in the Philippines.

News reports reveal that the initiative for the infrastructure fund is being pursued by GSIS with the Asian Development Bank and International Finance Corp., the private sector arm of the World Bank, as cosponsors (Infrastructure fund eyed, BusinessWorld, Nov. 16, 2011). This brings international professional expertise in finance and the highest degree of governance in its management, and insulates it from harmful political interventions beyond the term of this administration, a clear commitment to structural reform of a lasting nature which deserves public commendation. Moreover, it is expected that fund management will be outsourced to professional infrastructure experts with global track record which will help ensure that investment decisions are anchored on arms-length, transparent and non-political criteria and processes.

On the face of it, investing in infrastructure is a wise move for GSIS which needs to diversify its investment portfolio. The pension fund, with an asset base of about P600 billion (7% of GDP) has limited investment options. Based on its 2009 financial statements, over three-fourths of its investments was equally divided in only two asset types - government securities and loans, largely to members (and this was at a time when a portion of its portfolio was still invested overseas). Given its size, forays into the relatively small and illiquid local stock market through direct share purchases had tended to attract governance-related controversies. Likewise, the attempt to diversify its portfolio internationally in 2008 was short-lived as it coincided with the global financial crisis. The funds were redeemed last year and invested locally.

Such a diversification move is also in line with the recommendations of an international team of consultants commissioned by the World Bank and the Department of Finance that included pension gurus Estelle James and Alberto Musalem. Filipino actuary Ernie Reyes, financial analyst Christine Tang and I were privileged to join that team. Our 200-page report, Structural and governance reform of the Philippine pension system, 2007 had this to say on the need for diversification:

Diversification of portfolios is a significant issue for each institution (referring to GSIS, SSS, et al.). A basic problem is the diversification of investments within the relatively few opportunities offered by the local financial markets (both commercial and government securities). Pension related institutions already play a substantial role in the Philippines' capital market, with a capacity to move market prices. Part of the problem is that pension institutions tend to hold and manage stocks in individual companies, so even if their share in the overall stock market is not so great, they are able to move market prices for specific companies. Greater diversification domestically, and investing through pooled instruments would reduce the impact of investment by these institutions on price movements.

Romeo L. Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc., Philippine advisor of GlobalSource, and a board member of the Institute for Development and Econometric Analysis, Inc.