Build value for the aged

More investment in infrastructure assets would be an effective way for China to close its pension gap

Globally, most countries are facing a pension gap. Among them, China is experiencing pension pressure because of its rapidly-aging population.

More investment into infrastructure assets could be an effective way for China to close the gap.

There are three major reasons why the appeal of infrastructure projects as an investment class for pensions is growing. First, since they have the ability to generate stable cash flows when they mature, their profitability horizon matches the long-term horizons of pension funds. Second, there is a low correlation between infrastructure assets and the vicissitudes of the economic cycle. Third, infrastructure assets can hedge pension funds' sensitivity to inflation. In a nutshell, infrastructure assets offer an improved portfolio for long-term institutional investors such as pension funds.

However, theoretical advantages do not automatically generate real investment behavior. According to a 2019 survey of 99 pension funds of OECD members, 50 of the pension funds did not have any infrastructure investments, either directly or through listed instruments. Meanwhile, those pension funds with infrastructure investments demonstrated a certain pattern: In terms of the asset selection, pension investors tended to choose brownfield assets with relatively more stable investment profiles. Greenfield assets, whose risks as well as prospective returns are usually higher, require more comprehensive asset development and management expertise. So a trend in which the funds consider direct investment or hiring developers and asset managers with expertise and experiences during the construction phase has been observed.

As pointed out by Gordon Clark, a renowned expert in pension fund management at the University of Oxford, the most critical step for pension funds trying to establish a new direct investment capacity for infrastructure is to first consider what their overarching aims, available resources and external environments are for such an endeavor. The past evolution of pension fund investments in infrastructure has involved three major factors. To begin with, investment opportunities for pension fund capital vary amid different periods and regions. Following the wave of privatization that swept through the developed countries, the involvement of the private sector in the provision and operation of infrastructure has rapidly increased. In some cases, full privatization is not always feasible, or politically viable. Therefore, public private partnerships are adopted as a tool to balance the risk-return profile of the infrastructure assets and make them investable and available. PPP are especially applicable for China's scenario.

Furthermore, maturity and size mismatches are still a problem. The scale of pension funds varies significantly. Compared with large pension funds such as the Canada Pension Plan Investment Board, small pension funds may encounter barriers to entry when investing in mega infrastructure projects. Accessibility has also proven problematic in the past, particularly for smaller pension schemes in the United Kingdom. Last but not least, pension fund regulation plays a critical role, which in part explains why in some countries, institutional investors' traditional exposure to infrastructure has been via debt, such as bonds. This can be very challenging when pension funds need to diversify their portfolios and invest in the international market.

As for China, the potential pension gap caused by the previous pay-as-you-go pension system calls for a future pension portfolio with more stable and larger cash flows on the one hand. On the other hand, China's rapidly aging population might not be so patient. The solution to this dilemma is twofold. First, the short-term cash flow gap should be filled with alternative sources from the government. Second, although the best time to start such an endeavor was 30 years ago, the second-best point is now, since albeit aging, China's population is still growing.

Practically, infrastructure assets are very heterogeneous, thus pension funds need to go further than financial modeling and look deeper into the infrastructure projects for asset allocation. For example, healthcare infrastructure can be regarded as a tail wind that injects power into economic growth and investing in healthcare infrastructure could allow pension funds to hedge against the longevity of risk, the factor that most imbalances their revenues and obligations. When we explore the way forward, what is needed in the new decade in the 21st century is steady and sustainable investment in infrastructure. In other words, investment in green infrastructure may generate economic growth power and great cash flows through asset price changing in the short run as well as through utility in the long term. Green finance in China now is not only a good concept but also a good deal. China has done a great job in establishing a green financial system to support its economy's green transition but there is a significant part left behind, the pension funds.

Besides certain external barriers to be overcome, profound vision into sustainable development, professional governance based on aims and strategies, practical decision-making capacities taking liabilities' features into consideration and politically-enabling environment are all needed to open the new era of pension fund investment entering the 2020s.

Cao Shengxi is a research fellow at the China Finance 40 Forum. Sheng Xuanyi is a consultant for World Bank Group. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.