"There are risks and costs to a programme of action. But they are far less than the long-range risks and costs of comfortable inaction." - John F Kennedy
THERE ARE TIMES when the solution to a challenge seems beguilingly simple. South Africa has a huge infrastructure backlog. But by happy coincidence it also has an advanced capital market, where infrastructure providers are able to raise capital. The bond market is currently funding almost R80bn worth of infrastructure - without beginning to consider the potential of unlisted instruments.
However, that's a drop in the ocean of what's required. The public sector alone has committed to rolling out an infrastructure investment programme of R600bn over the next three years. Municipalities are enabled to borrow directly from the market and many private sector, non-profit and developmental agencies seek to raise project finance for socially orientated capital expenditure such as low-cost housing.
So why do fixed interest instruments like bonds make sense as the funding vehicle for infrastructure? Those who know their bonds will remember that tomorrow never dies. Infrastructure is all about creating capacity for future consumption and growth.
The World Bank estimated that a 1% increase in a country's stock of infrastructure is associated with a 1% increase in the growth path. Infrastructure projects tend to generate steady revenue flows over a long period of time that match the requirements of bond investors for regular, stable cash flow.
Water services, toll roads, mortgage repayments and waste disposal would all potentially fit that bill. Moreover, the existence of a deep yield curve in SA makes benchmarking feasible, with the additional benefit of enabling the intergenerational spread of payment for infrastructure that's enjoyed over a long period of time, such as a dam or toll road.
Infrastructure related bonds potentially enable the expansion of the risk/return profile available in the bond marketplace. Broadly speaking, infrastructure borrowers would fit into either general obligation or revenue specific capital raising needs. General obligation bonds would typically be issued by an entity like a municipality which is secured by general taxing powers.
From a macroeconomic viewpoint it also makes sense to encourage the funding of our future capacity from domestic resources. One of the unfortunate side effects of SA's capacity building is that we've built a current account nemesis approaching 9% of GDP. SA has a rich endowment of savings approximating R3 trillion in largely life and pension funds.
Of that, it's estimated that only around R10bn is dedicated to socially responsible investing (SRI), including infrastructure. Yet many potential areas of investment in SA that are linked to transformation - such as infrastructure provision and black empowerment - are also poised to offer competitive market returns by virtue of their investment and growth focus.
Yet commercially viable responsible investing is having a sluggish time showing up in pension fund portfolios. The precedent worldwide suggests SA is a laggard. In the US, Mercer Consulting estimated that almost 16% of retirement assets were invested in SRI strategies in 2007. That figure is around the low double digits in Britain and Australia and slightly lower in continental Europe.
How do you explain the low take-up of responsible investing in SA? We have an exceptionally well-developed financial sector and a crying need for social spending. So the potential to make money from investing responsibly must exist. In fact, it could even be argued that retirement funds that don't participate in SRI are potentially excluding themselves from growth nodes in SA's economy.
A recent study by Unisa's Centre for Corporate Citizenship highlighted some of the reasons for low interest and understanding of SRI in the SA pension fund industry - manifest in the low levels of investment. They aren't insurmountable and mainly revolve around issues of understanding with respect to definitions of responsible investing and the need to believe that responsible investing will enhance financial returns.
In a nutshell, the problem is not that investors are against investing in high social value outcomes per se, but that there is enough uncertainty and misunderstanding of how, why and where to do so to stop them actually doing it. Such uncertainty translates into avoidance, which translates into a lack of demand for products, which in turn, translates into a shortage of supply of appropriate product. The trick, then, is to break this negative cycle by letting investors see the way more clearly.
The relatively narrow evidence in SA across fixed interest, property and equity SRI funds indicates that, on balance and at a minimum, investing in SRI products doesn't prejudice performance relative to the mainstream peer group. Of particular interest is the fact that the volatility of returns was lower over a five-year period for all SRI asset classes when compared to the aggregated return of the peer group asset class, resulting in better Sharpe ratios.
Investment in infrastructure pairs both financial and social performance objectives. There can be no more direct contribution to the growth and stability of SA's society than the provision of far-reaching infrastructure. It should be both a right and a benefit to pension fund members to invest in that future.
One of the most effective and efficient ways of delivering infrastructure should be at local authority level. Wise municipal borrowing could encourage a more efficient allocation of resources than central Government interventions. Infrastructure delivery is ultimately needed at a local authority level, where bond issuance is an untapped source of funding.
Borrowing at that level would also achieve greater efficiencies from matching demand and supply of funds. The ability of bond funding to be long term potentially results in a better matching of assets and liabilities, an inter-generational spread of repayment and generates a revenue flow that can perfectly match bond investor needs. In addition to municipal bonds, many NGO or private sector providers require project financing at a municipal level to provide infrastructure solutions.
The broad macro environment is generally supportive of the issuance of municipal bonds when compared to some of the precedents that seemed necessary to developing municipal markets elsewhere worldwide. SA has achieved a good measure of macro stability through credible policy making. However, that seems to be floundering recently and political stability has deteriorated. The existence of a well-established bond market with extensive benchmarks and limited crowding out from Government is a positive feature. So too is the presence of a supportive legal environment (the Municipal Finance Act and Generally Accepted Municipal Accounting Principles) and tax policies that don't disadvantage bonds.
The US is testament to the potential success of municipal borrowing to fund infrastructure. It's the largest sector of the bond market, has delivered the best risk adjusted (and after-tax) returns and evidenced much lower defaults than corporate bonds with higher recovery rates.
Christian Ragnartz, of the Swedish pension fund AP7, has stated the lack of action on SRI is the biggest market failure ever. "The consequence of the concept that 'the market is always right' is a cynical and irresponsible approach that belongs in the past when we didn't have global common guidelines - or democracies, for that matter.
"The seriousness of global warming is one example where the market has proved flawed. Climate change is the biggest market failure ever. Relying on market forces has so far led us into a dangerous situation where it's hard to see how investors could argue they'd taken their fiduciary responsibility seriously. I'm not suggesting that ESG guidelines would have solved the problem but they would at least have given the investment community a greater chance to be part of the solution."
To again quote the inspiring words of JFK: "If a free society can't help the many who are poor, it can't save the few who are rich." We have both the means and the opportunity to make effective investment decis-ions with which we can begin to enact, the next aspiring leader of the New World's urge that "perfection starts here". Actually, Mr Bond, you only live once!
Heather Jackson
JACKSON was one of the founders of African Harvest Fund Managers (AHFM) and is recognised as a leading bond manager. She started her career as an economics and bond analyst at Merrill Lynch, staying four years. She then spent three years as a bond portfolio manager at Southern Life Asset Managers before becoming head of Investec's fixed interest team in 1998. She joined Prudential Portfolio Managers in early 1999 and left at year-end to establish AHFM (Value). She's head: socially responsible investments. She's been a regular lecturer on the fixed interest market at UCT's finance honours programme, holds a BA (Hons economics) and is a CFA.