Governments have long orchestrated domestic institutional investor home bias, particularly by drawing investment boundaries to ensure large allocations to domestic assets.
The 1990s saw the advent of new investment doctrines, including the prudent person principle, and a new set of opportunities brought about by the advent of the euro. This came as consultants were preaching a new gospel of global asset allocation and risk in equities, bonds and alternatives.
The scrapping of quantitative investment rules in many places led to a blossoming of European and globally focused investment strategies.
Many pension funds embraced their new-found investment freedom with zeal, amassing both sizeable holdings of global assets, as well as corresponding expertise and fluency in allocation in a variety of investment areas. For many, domestic allocations became a mere afterthought.
As globalised asset allocation philosophies took root, European and other economies also benefited from an influx of foreign capital, broadening the investor base in a variety of assets.
It has since become clear, however, that foreign investment alone will not be enough to meet Europe’s vast investment needs. Problematic in this equation is ‘undesirable’ inward capital – depending on your geopolitical views, this could include Chinese investment in public infrastructure.
Therefore, it’s unsurprising that initiatives such as the UK’s Mansion House Accord, lionise domestic capital. However, these projects also underscore two things – one is the relative lack of sophistication of politicians and policymakers about capital allocation (too many badly governed public infrastructure projects underscore this point). Smarter frameworks are needed.
A recent report by the International Centre for Pension Management (ICPM) in Toronto highlights the need for “investable windows” – alignments of policy, incentives and investor needs – that will create the optimal conditions for investment (see viewpoint, p14). This itself emphasises a second point – that well-designed projects can create a ‘win-win’ that benefits taxpayers and governments by reducing funding costs and creating long-lasting assets for the public good.
Europe clearly has vast investment needs that, if met, will underpin the future prosperity of hundreds of millions and help secure the continent’s defence and security. There also needs to be focus on the investment ecosystem. In the US, Bell Laboratories is a well-rehearsed example of post-war private R&D that benefited from vast public defence expenditure. As European defence expenditure grows, which ecosystems will allow benefits to flow between the public and private sectors?
ICPM’s research found 70% of pension funds reporting some kind of pressure, usually informal, to invest in domestic infrastructure, housing or energy. There are clear signs of overreach – particularly in the UK where the legal limbo of “mandation” is leading to warnings that trustees could be challenged if things go wrong.
Perhaps, in time, we’ll welcome sophisticated capital again, whatever its source. That, however, is not likely soon. In the meantime, governments need to wise up to the needs of their domestic investors.
Liam Kennedy, Editorial Director
