The road to lousy infrastructure investments is paved with good intentions

Image: Reuters/Jonathan Drake
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There may be only one policy issue that all Americans can agree on: the country needs an infrastructure revamp. Bridges and roads are “crumbling,” the water is dirty, and airports are terrible. Every politician promises to fix it, but they never do.

Infrastructure projects never seem to get off the ground in large part because most of the spending happens at the state and local level. The thing is, many states and municipalities don’t have the money to spend. They are reluctant to issue more debt or raise taxes, and they have to make large contributions to their pension funds.

But what about all that money in pension funds? It seems sensible that at least some of it could finance these much-needed infrastructure projects. After all, infrastructure revenues can pay off over the long term, and the revenues they generate are uncorrelated with other assets that pension funds invest in, like stocks and bonds. It sounds like a win-win, or at least New York Mayor Bill de Blasio thinks so.

But not so fast. A new study measured the return (pdf) on these projects achieved by pension funds. These kinds of investments have become more popular in the past decade as a way to finance infrastructure instead of taxpayer revenue. Different projects are normally packaged together into different infrastructure funds. Investors in infrastructure funds typically include sovereign wealth funds, private pension funds, insurers, banks, university endowments and foundations, and public pension funds. Public pension funds make up most of the deals. When the data is limited to US funds, 36% of all infrastructure investment comes from public pension funds.

But public pensions also perform the worst. The money public pension funds invest has a smaller chance of a successful exit and generates smaller returns. Their internal rate of return is about 1.3 percentage points less than what other kinds of investors earn. For most investors, infrastructure funds perform about as well as typical private equity investments. But for public pension funds, infrastructure tends to do worse than other alternatives, an even just an S&P index fund.

There are many reasons that could explain the underperformance. Lower returns aren’t linked to preferences for longer-term projects or less risk. The study’s authors find more compelling evidence for less skill on the part of pension investors. There may also be political pressure to finance popular but not economically advantageous projects. Public pension funds are also more likely to invest in projects within their state, which may not be the best on offer. Thus the authors are skeptical that investing directly in infrastructure projects, as opposed to infrastructure-focused funds, would be any better.

Perhaps it still seems like a fair trade, since taxpayers benefit from better infrastructure, regardless of whether it generates an outsize return for pension funds or not. But someone must pay, eventually.