Contractual savings institutions, such as mutual funds, pensions, and insurance companies, can drive investments that offer financial returns while creating social and environmental impact.
Institutional investors, such as mutual funds, pensions, and insurance companies, can play a powerful role in making profitable investments that support the Sustainable Development Goals.
Depending on the risk-return profiles and liquidity needs, insurance companies and pensions can provide alternative funding to complement bank financing. Moreover, because they can absorb less liquidity than other assets, they can offer better pricing and longer maturities.
The diverse nature of infrastructure debt provides an added attraction to insurance and pension investors. A diversified domestic investor base can contribute to the trading depth and expand the range of investment options across a wide range of sectors and industries. This can help investors diversify portfolios and manage risk better by developing hedging instruments.
Investors can also diversify benefits through the debt capital structure. For example, due to its illiquidity premium and low expected loss, senior debt can offer an attractive valuation. In contrast, junior debt can provide a higher absolute return while still benefiting from the same resilience.
Also, by funding riskier activities traditionally not served by the banking sector, insurance companies and pension funds can contribute significantly to economic innovation and help shift the focus from capital-intensive growth to intangibles-intensive investment that caters to the needs of a service-based economy. Thus, domestic firms would need to rely less on retained earnings to finance investments.
Collective investment funds, such as mutual funds, including money market funds, meanwhile, can reduce the cost of diversifying risk. By allowing retail investors to access professional fund management services easily, they facilitate an increasing role of financial incentives, financial markets, entities and institutions in the functioning of national and international economies, often termed as “financialization of savings”. Their shorter investment horizons facilitate price discovery and create liquidity. And they enhance market transparency, governance, and credit rating functions by reducing information asymmetries and help sustain the vitality of the entire financial ecosystem.
Assets under management in the Asian and Pacific private market reached $1.62 trillion in 2019 and forecasts them to grow to $4.97 trillion by 2025.
As the markets become more sophisticated, the pool of local currency savings progressively diversifies from the banking sector into the growing nonbank institutional investor base in local currency, including cash and debt. Institutional investors also participate as qualified investors in the spot markets and financial derivative transactions, improving a country's overall risk allocation and financial stability. Doing so makes the market more attractive to international investors, who are comforted by the presence of a local, well-established domestic institutional investor base.
Asia's savings rate is very high. And the massive amounts involved mean that mobilizing contractual savings can be a "game-changer" for infrastructure.
Contractual savings institutions, such as insurance companies and pension funds, collect funds at periodic intervals on a contractual basis and invest them in long-term securities such as corporate bonds, stocks, and mortgages in such a manner that they these financial instruments maturie when contractual obligations have to be met.
Prequin estimates that assets under management in the Asian and Pacific private market reached $1.62 trillion in 2019 and forecasts them to grow to $4.97 trillion by 2025. Thus, allocating just 5% to infrastructure projects would have a significant impact.
And the size of institutional investors differs widely in the region. Financial hubs such as Singapore, have more than 50% of assets derived from foreign capital inflows. In countries such as the Philippines and Indonesia, the asset size of institutional investors to GDP is only about 13% and 6%. Naturally, countries with strong domestic institutional investors have more potential to tap into foreign investors for infrastructure development.
According to SwissRe, private investment—particularly some $80 trillion in assets under management held by institutional investors—is paramount to bridge the infrastructure financing gap. Yet, these investors’ participation in developing countries’ infrastructure remains very low, at less than 1% of global portfolios.
Infrastructure investment provides a strong economic stimulus with a multiplier effect that can help to rebalance growth. According to the IMF, an investment of an additional 1% of GDP increases output by 0.4% in the year that investment is made and a further 1.5% in the four years following the investment.
By helping to raise the weight of institutional investors in channeling savings into financial market instruments and reducing that of the banking sector, governments can seriously boost long-term growth prospects and bridge the massive infrastructure financing gaps in critical sectors, such as housing, climate, and infrastructure.
Since infrastructure assets have long life cycles, investment decisions must align with the Paris Agreement's national and global targets for reducing greenhouse gas emissions. Otherwise, they are likely to generate idle assets before the end of their useful lives. Infrastructure projects must also consider the resilience of investments to climate change, such as increases in temperature and variations in precipitation levels, to avoid unintended consequences in the form of interruption of essential services to the population or the flow of revenue collection related to such services.
Given the inherent influence of contractual savings institutions in intermediating savings, institutional investors are well-placed to invest in impact-focused opportunities. Governments need to promote contractual savings institutions by guiding structured investments that drive financial returns while creating social and environmental impact.