KVIG Informative

Many people own a small piece of a toll road or rail line without knowing it, because their retirement systems invest in infrastructure funds. Research on how those investments perform is more mixed than the pitch behind them.

Infrastructure has become an asset class for large institutions, drawing pension funds, insurers, sovereign wealth funds, banks, endowments, and foundations. Researchers Aleksandar Andonov of the University of Amsterdam, Roman Kräussl, and Joshua Rauh of Stanford’s Graduate School of Business and the Hoover Institution studied how these investors actually fare. Their paper appeared in the Review of Financial Studies in 2021, and an earlier version circulated through the National Bureau of Economic Research.

The Indirect Route Most of these investors do not buy a road or an airport themselves. They commit money to a closed-end private fund that pools capital from many investors and buys stakes in infrastructure deals, including P3 concessions. Such funds typically have a finite life of about 10 to 12 years, after which the fund sells its holdings and returns the money. The route is indirect in two layers: the pension fund owns a share of the fund, and the fund owns a share of the project. A 2023 academic study of pension funds worldwide found that only 13 percent of the pension funds in its sample managed infrastructure investments internally in 2018.

What Investors Expect Institutions commonly include infrastructure because they expect long-term, low-risk, inflation-protected returns that move independently of the stock market. Andonov, Kräussl, and Rauh tested that expectation against fund data. They found that closed infrastructure funds pay out cash in a pattern very similar to private equity buyout funds and real estate funds, earning most of their returns through capital gains and relatively quick exits. The funds did not provide more stable cash flows than other private funds, and the spread of outcomes was as wide as for buyout and real estate funds.

Public Investors Versus Private Investors The same research found that public investors, meaning public pension funds, government agencies, and sovereign wealth funds, performed worse than private institutional investors in these funds, even though they held stakes in deals with similar project stage, concession terms, ownership structure, industry, and location. Public investors earned an internal rate of return about 1.8 percentage points lower and a multiple of invested capital about 0.038 lower. In the working-paper version, the authors estimated that the shortfall amounts to an implicit subsidy to infrastructure as an asset class, between $730 million and $3.16 billion a year for U.S. public pension funds depending on the benchmark. They attribute it to selecting funds that invest in poorly performing projects.

A Competing View The evidence does not lead everyone to the same conclusion. A policy brief from the Stanford Institute for Economic Policy Research, built on the same research, agrees that closed funds do not deliver more stable or diversifying cash flows than other private funds. It also argues that user fees and P3s funded with institutional capital hold promise, because they can improve maintenance, cost-benefit analysis, and the prioritization of projects. The authors add that growth in infrastructure investing has been driven largely by institutions tied to government, and that those investors increased their allocations in response to regulation promoting environmental, social, and governance goals.

How to See It for Yourself Nevada’s Public Employees’ Retirement System publishes a comprehensive annual financial report that includes a consultant’s report on investment activity. That document is where members and residents can see how the system’s portfolio is allocated and how its alternative investments are described. Whether a given fund holds infrastructure stakes is a question the report, not an assumption, can answer.

The word “investor” in a P3 can mean a private equity-style fund, a bank, or the retirement system of a public employee, often stacked in layers. Who profits depends on the fund’s terms, the timing of its exit, and the skill of whoever picked it. When reading about the next large project, it helps to trace the layers from the agency to the project company, to its lenders, and up to the funds that own it.