The COVID-19 pandemic has crushed economies across the globe – and we expect the recovery will be a grueling and inconsistent process. This crisis, however, also creates opportunities to unite historically disparate investor groups to help build economic and market sustainability and resiliency.
Public-private partnerships and solutions that bring the rather arcane world of “development finance” into mainstream investment practice could be an important, and beneficial, development to come out of this extraordinarily difficult period.
The current pandemic is likely to hasten existing economic trends, while shifting preferences among savers and consumers will alter the structure of economies and markets across the globe. In the developed world, yields have fallen significantly – hurting savers, in particular those closest to retirement. While the incremental liquidity provided by central banks has supported equity market valuations, it only acts to pull future returns of equities to the present time, which leads to lower equity return expectations for the future.
The developing world has the reverse problem. Many developing economies, particularly in Africa, have younger demographics but lack the capital and infrastructure required to harness the energy of the population to create future prosperity. In the United States, small and midsize enterprises (SME) represent half of all jobs in the country and 64% of new job formation. The same dynamic exists in Africa, where SMEs contribute 60% of total employment and four of every five new jobs. What is missing is the ability for the private sector to finance both the infrastructure and the capital needs of these companies. The pandemic amplifies this imperative.
Surplus capital from developed countries has historically found its way to the developing world through governments. Long-standing supranational development finance institutions (DFIs) – such as the World Bank’s International Finance Corporation and the Inter-American Development Bank’s IDB Invest – have created networks and processes that allow them to lend directly to companies in the developing world, and they are very effective in their sourcing and management of these investments. The other channel has been for the private sector to invest in emerging market government bonds, which in turn have been used to finance much-needed infrastructure.
What is still undeveloped is the ability for the private sector to use its savings surplus to finance infrastructure projects and companies in developing markets directly.
While there is a big role for the private sector to help facilitate these flows, the private sector cannot do it alone as it does not have technical expertise in local market lending in developing economies. Building direct lending capabilities is very costly even within the time-tested legal frameworks of the most efficient capital markets of the U.S. and the EU. Designing a platform in developing economies using the private sector is simply cost-prohibitive, or has been.
This is where public-private partnerships can fill the void. Since DFIs have the technical expertise and the networks, if we can successfully develop a partnership between private-sector asset owners and the DFIs, we can form a unique win-win-win scenario. Such a partnership would allow local developing market companies to gain access to long-term patient capital for infrastructure and other capital-intensive projects. Global DFIs can provide technical expertise in sourcing deals and gain a source of revenue for this service, which in turn will increase their ability to lend and multiply their reach and impact – especially urgent in the current global health and economic crisis.
There is also a role for smaller regional DFIs, which can participate in risk-sharing through innovative arrangements and thus gain a global reach for their mission. Risk-sharing will broaden the eligible investor base in developed markets from pension funds to pension insurers and therefore potentially unlock a vast amount of assets currently unable to participate in developing market finance.
There is also a critical role for asset management firms, given their investment expertise and their knowledge of the needs of institutional and retail clients around the world. With help from investment managers, pension funds and pension insurers will be able pool their resources and allocate part of their portfolios in diversified sources of return in developing markets, and meet their stakeholder needs for increased sustainability-oriented investment, especially those aligned to the U.N.’s Sustainable Development Goals.
We believe this public-private partnership opportunity is within reach, and will catalyze investments that heretofore have been difficult, if not impossible, to implement. If successful, it could truly be a win-win-win for developed economies, pension participants, and development finance.
Scott Mather is Chief Investment Officer for U.S. Core Strategies at PIMCO.