Over the past 30 years, pension funds have accumulated trillions in pension assets by investing in high-performing global portfolios. Key to their success has been the ability to invest free from government pressures. The resulting large asset pools have allowed millions of pensioners to enjoy a financially healthy retirement.
Unfortunately, these large asset pools are now being eyed by cash-constrained governments as a source of funding for domestic growth projects such as infrastructure. Magnus Billing, the former CEO of Swedish pension fund Alecta, explained the problem well in a recent op-ed for IPE: “When you’re sitting on trillions in pension assets while your economy stagnates, the temptation to ‘guide’ allocation decisions becomes overwhelming.”
When governments call on pension funds to be patriotic and invest more domestically, they ignore the funds’ first and primary fiduciary responsibility, which is to act in the best interests of their members.
Pension funds scrutinise domestic investments like every other investment and impose a set of financial, legal and operational requirements to ensure the long-term viability of their portfolio.
These requirements form the funds’ ‘investible window’. Returns must be competitive and commensurate to the risk undertaken. Investments must be scalable and sufficiently liquid. Investments must also come with clear governance and control rights. And projects with proven cashflow streams in established industries are typically preferred to venture projects in new markets.
Governments are considering imposing domestic mandates to force domestic investment. This is not a good idea. Mandates forcing pension funds to invest in assets outside their investible window disregard the careful calibration of return, financial risk, and other legal and operational considerations. Overlooking this balance results in financial losses to pensioners.
Tax on pensioners’ wealth
It is analogous to imposing a tax on pensioners’ wealth. Mandates also set a precedent for government interference by taking away a fund’s independence over its investment strategy, which is critical to its success.
Rather than calling for economic patriotism and threatening mandates to enforce domestic investment, governments need clarity about what makes an investment fall into a pension fund’s investible window. They then need to structure domestic projects with characteristics that incentivise pension funds to want to invest domestically.
This is a win-win solution: governments leverage pension capital for domestic growth while preserving pension fund independence. Even better, governments that set up the right environment for domestic pension capital also attract the much larger pool of global institutional capital.
Governments can act in multiple ways to push domestic projects into the pension funds’ investible window. One way is ‘asset recycling’, a practice successfully implemented in the Australian state of New South Wales. The government builds an infrastructure asset and then sells it or leases it to pension funds, which then take charge of operating the asset in a regulated environment.
Infrastructure assets such as transmission grids and power plants have appealing investment properties for pension funds. They provide steady returns over the long term, which aligns with the pension funds’ liability profile. Being large, they provide scale benefits for the funds. They are pre-built and already operational, which means that funds are not exposed to construction risk.
The asset transfer also gives pension funds the opportunity to own and control the asset. For governments, the proceeds from the sale provide financing for the development of new infrastructure assets. For example, in New South Wales the sale of the transmission grid network to pension funds has allowed the government to develop new projects such as the Sydney Metro.
Incentivising pension funds
Another way is to design a regulatory framework that incentivises pension funds to supply capital early on in the project lifecycle. The Netherlands is an example where the government works together with large pension funds to tackle the housing shortage and build affordable and sustainable housing.
The design of market-based rent-setting mechanisms ensures affordability while maintaining commercial sustainability for pension fund investors. The large-scale nature of this development project also provides scale benefits.
A third way is to develop new markets such as AI, quantum technologies, and digital and green infrastructure. A core barrier to private investment in new markets is that they are complex, unproven, and lack scale. Governments can use public investment funds to transfer some of the risk away from the private sector, help the projects establish a track record, and build scale.
Canada has taken this approach, launching the C$15bn (€9bn) Canada Growth Fund in 2022 to catalyse private investment in clean technology and energy-transition projects.
“When governments call on pension funds to invest more domestically, they ignore the funds’ first and primary fiduciary responsibility which is to act in the best interests of their members”
The fund deploys a range of government-backed de-risking tools and concessional financing to finance new technologies such as carbon capture and geothermal energy that may not yet fall into the pension funds’ investible window perhaps because the projects are too early-stage or too small in size. Europe’s newly launched Scaleup Europe Fund has a similar goal: to help build scale and attract institutional capital to Europe’s innovation ecosystem.
This year the International Centre for Pension Management (ICPM) hosted a working group of 17 senior pension fund executives to reflect on these questions. The final report presents a practical framework to leverage pension capital for domestic growth, with the goal of promoting a constructive conversation between governments and pension funds.
Domestic institutional capital is available. To unlock it, governments need to think like investors, design projects that enter the funds’ investible window, and build institutional trust not just one project at a time but across the system.
Sebastien Betermier is executive director at the International Centre for Pension Management
Onno Steenbeek is managing director, strategic portfolio advice, at APG Asset Management
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