Pensions: in it for the short-term

You’ve read it so many times that by now that you can probably recite it like a mantra: pension schemes, with their long-term liabilities, are the perfect match for infrastructure. Infrastructure, so the saying goes, is an asset class that is suited to investors with long-term horizons. So you'll have asked yourselves, as we have (more often than is good for our collective sanity): Why are pensions not embracing the asset class whole-heartedly?
 
A policy note circulated by the Organisation for Economic Cooperation and Development (OECD), the economic policy group for the world’s developed countries, at a recent G20 meeting in Paris, lays most of the blame for this on the shoulders of governments. It is the latter, the OECD argues, that have to create the right environment for pensions to increase their investments to infrastructure.
 
So far, so orthodox. But the next insight in the OECD’s policy note might raise a few eyebrows. Basically, governments need to create the right regulatory environment not so much to satiate pension demands for easier access to the infrastructure space, but, rather, because pensions have become too “short-termist” in their investment strategies.
 
“Signs of such growing short-termism include the fact that investment holding periods are declining and that allocations to less liquid, long-term assets such as infrastructure are generally very low and are being overtaken in importance by allocations to hedge funds and other high frequency traders,” the OECD writes.
 
Perhaps surprisingly, it turns out that “even supposedly long-term investors such as pension funds end up having portfolio turnover much greater than originally intended,” the OECD says. The problem lies in the current investment culture: both external and in-house asset managers have “performance-based remuneration that is often based on short time periods,” the note reads.
 
Hence, they have little incentive to increase their allocations to investment strategies that will only reap dividends in the longer term. From this perspective, it’s tempting to see two recent developments as potential evidence of pensions’ alleged “short termism” in infrastructure investing. One is the decreasing popularity of open-ended fund structures. The other is the increasing focus on remuneration strategies that give fund managers a portion of yield as opposed to carried interest.
 
As we wrote here a week ago, institutional investors applaud “the theory of open-ended funds while failing to vote with their wallets,” preferring vehicles that will allow them to get their money back sooner rather than later.
 
The same goes for remuneration strategies based on yield. Some pensions argue they prefer access to yield from day one and would rather infrastructure funds focus on that aspect rather than returns. But as Alain Rauscher, chief executive of Antin Infrastructure Partners, argues in the March 2011 issue of Infrastructure Investor:
 
“it’s easy to deliver some 5 percent or 6 percent of yield if you do not invest in an asset. You cut your capital expenditures and then you are going to get your assets back in five to 10-years’ time in a poor condition. This is not in the long-term interest of investors.”  Perhaps not, but maybe it isn’t a strategy with the long-term in mind.
 
All of which poses an interesting challenge: how to change the current investment culture and re-orient it toward the longer term? The OECD rightly argues that changing the current environment requires a “transformational change in investment behaviour” – a change unlikely to be delivered by the market, the organisation adds.
 
Whether governments – themselves prey to the short-term pressures of the electoral cycle – are in the best position to enact this change, as the OECD contends, is open for debate.