As pension funds carry out their mission of building bridges to financially secure retirements, they may also be in the unique position of being able to help the nation rebuild its bridges and other tiring infrastructures.
In 1981, author Pat Choate's book, "America in Ruins," revealed the level of our infrastructure's disrepair, spurring media attention, hearings before state and federal legislative forums, and efforts to rebuild crumbling highways and other public facilities. But 12 years after the book's publication, this past winter showed that serious problems remain--always there, if only concealed below the surface.
Across the country, governmental officials have identified $500 billion of needed infrastructure improvements. Clearly, on a wish list of that magnitude, some projects have a lower priority. Even so, necessary projects run the gamut from water filtration plants, electric generation and transmission systems, new or renovated airports and sea terminals, toll roads, affordable housing, pollution control facilities, and a variety of others, all vying for finite dollars from conventional sources.
Against that backdrop, pension funds, which control some $4 trillion in assets, are largely overlooking the new investment havens represented by municipal debt, particularly taxable bonds that now offer the combined benefits of competitive returns secured by dedicated revenue streams.
By allocating greater proportions of their assets to municipal bonds, pension funds could meet their fiduciary obligations to beneficiaries while providing the support needed to allay specific public needs that would also help the economy continue growing.
At historical growth rates, pension funds should double their assets before the end of the decade. If just 5% of their current asset pool--a fiscally responsible level--were directed toward municipal infrastructure needs, the investment in rebuilding our cities and their transportation links would equate to a $200 billion capital infusion.
This is not a call for charity.
Understandably, some pension fund managers have expressed concerns that their focus could be diverted if they had to apply some arbitrary "public benefit" benchmark to their investment options. However, Standard & Poor's Ratings Group believes pension funds could bolster their support for public infrastructure projects while meeting their fiduciary responsibilities through investments in a marketplace characterized by its historical safety, security, and liquidity.
Further, by opting to increase their participation in the municipal bond market, pension funds may be able to avoid having investment requirements imposed upon them, as the banking industry has discovered. While laws pertaining to mandated community investing by banks have worked out well, by and large, industry does better when the marriage of self-interest and public good is based on satisfying mutual interests rather than convenience.
The Community Reinvestment Act [CRA], passed in 1977 by a Congress concerned that lending capital was not being adequately retained within the banks' principal services areas, requires banks to retain a portion of their loan activities within their localities.
The CRA reqires banks to invest in their communities, but he obligation does not extend to having to write "bad deals." Similarly, insurance companies, mutual funds, and other large institutional investors are recognizing that targeted investments generate benefits that can flow in both directions.
Just as CRA admonishes banks not to do "bad deals," the Employee Retirement Income Security Act of 1974 [ERISA], the federal law governing pension funds, requires that the funds' management always act in the best interest of the plan beneficiaries.
The two objectives, investing in worthwhile public projects while earning a responsible rate of return, are not mutually exclusive. In fact, there are fresh signs that pension plans, among them the nation's largest, are wisely beginning to see the gains to be made in the publicly-supported debt market.
In March, two of the nation's largest pension funds, the California Public Employees Retirement System (CALPERS) and the California Teachers' Retirement System (CALSTERS) combined for a $225 million investment to build affordable housing, an initiative said to be the largest private-sector deal of its kind. CALPERs' loan, set at one percentage point above prime, certainly offers a competitive yield based on comparable investments with similar risks.
In addition, public pension funds in at least 21 states are required by statute to make "Economically targeted investments," a way of encouraging public pensions to promote economic development within the states in which the contributors reside. So far, the assets earmarked in those states are estimated as high as $20 billion.
As noted earlier, the benefits of investing in such public projects can flow two ways: The nation renews its infrastructure as retirees benefit from competitive returns in a marketplace that is safe, liquid, and diverse, the primary elements of any long-term investment portfolio.
Clearly, the municipal debt market fits that description. With approximately $1.2 trillion in outstanding debt, half the par value of which typically trades each year, municipal debt has demonstrated liquidity in a well-established market. By the same token, it is diverse, with Standard & Poor's rating 15,000 governmental issuers, more than three times the number of currently rated corporate issuers.
Outstanding municipal debt ranges from a few hundred thousand dollars to more than $10 billion, earmarked for a broad range of public uses: to purchase a fire engine, build a school, construct a fuel-to-energy plant, or a range of other needs.
A pension fund's interest in financing a fire engine may be lukewarm, but it could easily be interested in investing in a toll road backed by the revenues from the traffic volume. General obligation bonds and other public sector facilities are backed by the issuer's capability to raise taxes, its full faith and credit, or, if appropriate, through revenue bonds--an issue with a dedicated stream of revenues--as is the case with a toll road or a sports arena.
Revenue bonds are now the security of choice for about $65% of the new issues in the municipal market, especially for infrastructure projects where the municipality may be limited in raising new GO debt because of taxpayer wariness or internal controls. Structured financings and derivatives also enhance a pension fund's access to diverse securities which can be designed to meet the fund's specific needs.
Whether tax-exempt, as GO bonds, or taxable revenue bonds, public sector debt as shown itself to be extremely safe. The number of issuers and par values that have ever failed to meet their obligations is minuscule, well below 2% of the total market, even accounting for the housing and health care sectors, which vary slightly above the norms.
In addition, issuer information tends to be widely available on new issues, and is disseminated through a variety of accessible media and financial services, including Standard & Poor's.
About 70% of the municipal market is rated by Standard & Poor's and other rating agencies. The agencies review the debt instruments and track the issuer's financial condition in order to alert investors of any changed circumstances that could affect the ability and willingness to meet stated interest and principal payments.
If enacted, pending proposals to expand municipal market disclosure will bolster the openness that already exists in the secondary market. And if a pension fund investor needs additional disclosure, it's possible that the size of their investment would enable them to negotiate further assurances in legal and supporting documents.
In the case of infrastructure investments, pension funds have experience with the investment fundamentals that guide them in their decisions. The approach is similar to finding suitable debt securities in the taxable or international markets, particularly relating to project financings. By transferring their existing credit analysis skills to the domestic, municipal market, pension fund managers should be able to price deals more favorably than initial appearances suggest, provide their members with the superior returns that can accrue from cross-over buying, and avoid the added risks stemming from currency fluctuations and unexpected, sudden political changes.
Public bond issues typically are long-term issues, matching the pension funds' appetite for extended maturities. Many issues cover 30 years and finance assets with useful lives well beyond scheduled debt retirement. Added to the positive mix is the increasingly prevalent use of derivative and other hybrid securities, market instruments that, if properly structured, shelter issuers and investors from risks that were previously present.
As pension funds take a harder look at the benefits of investing in needed infrastructure -- investments that will earn them returns well worth the risk -- they will also reap the rewards of building solid foundations for the future, for their retirees, and for their children.
