Why Pension Funds Shouldn’t Buy Infrastructure

“Illusory” risk-return profiles and a lack of quality supply seriously detracts from the attractiveness of the asset class, argues Deutsche Bank.

Investors may be overestimating the capacity of infrastructure as an asset class to meet return requirements, according to Deutsche Bank analysts.

Infrastructure projects’ “supposedly attractive risk-return profile” is “illusory,” the analysts wrote in a multi-asset research note.

“Bringing private capital to bear on the public infrastructure problem is an idea whose time has yet to come.”While there is an estimated $1 trillion funding gap for infrastructure due to cuts in government spending in many developed markets, private investors “could provide just 15% to 20% of this projected funding shortfall,” Deutsche Bank said.

“The vast majority of infrastructure is a public good that does not offer a viable revenue model to cover costs let alone provide adequate returns,” the analysts wrote. “The relatively few revenue robust projects have little difficulty attracting capital. Indeed for these projects the problem is too much money chasing too few opportunities.”

President Barack Obama has launched a number of initiatives aimed at increasing private sector investment in infrastructure, including a $10 billion fund aimed at rural opportunities, and the Build America Investment Initiative.

In the UK, the government has pushed through major reform of local authority pensions with the aim of creating asset pools with the scale and resource to invest in infrastructure assets. However, several commentators have expressed concern that the supply of suitable assets will not meet demand.

In addition, as projected returns are based on cash flows and “appraised values,” the actual returns available from infrastructure are very uncertain. With more money flowing into the sector, regulators “may require more rigorous appraisal methods, leading to more volatility, lower Sharpe ratios and higher correlations,” Deutsche Bank said.

The analysts argued that “it may take another crisis for the public and private sectors to collaborate and create investment vehicles that make economic sense.” Alternatively, larger collaborations between investors—as occasionally seen between Canadian and Middle Eastern funds—could the achieve critical mass and expertise necessary for successful direct investments, they added.

“Until then, investors interested in infrastructure must rely on more traditional investments, such as utility equities and bonds, syndicated project loans, and municipal revenue bonds,” Deutsche Bank said. “Simple as it sounds, bringing private capital to bear on the public infrastructure problem is an idea whose time has yet to come.”

Related: Largest Investors ‘Dominate’ Infrastructure Market & US Attempts to Remove Barriers for Infrastructure Investors