Matching the funding gaps in the next decade

Taponeel Mukherjee, Indo-Asian News Service

As we come to the end of a decade that witnessed unprecedented monetary policy expansion, an eye on the trends observed and those rapidly in play, helps examine critical points of action, especially, for India.

The past decade saw the S&P 500 give an annualised return of 13.27 per cent (dividends reinvested) between December 2009 and December 2019, a return that is both attractive and symbolic of the excellent run the equity markets saw globally. Additionally, while the stock market bull run over the last decade was one side of the coin, the rally in the bond markets with global interest rates heading significantly lower was the opposite trend. While those part of the bull-run in stocks can rejoice, two fundamental issues deserve careful attention from investors, governments and the general public alike as we head into the next decade, namely, the underfunded pension funds in the developed economies and the substantial investment funding gap in emerging markets.

Data indicates that global trends of increased longevity, rapid urbanisation and higher demand for food and energy are here to stay, but these trends have ramifications both at societal as well as the economic decision-making level. In the developed economies, underfunded pension funds is an issue that merits attention, especially as the population ages and lives longer. At a layman’s level, the assets that some pension funds hold is smaller than the liabilities, i.e., the money they must payout in the future. The current regime of low-interest rates has further exacerbated the problem of low returns. The “funding gap” that has emerged for funds also indicates the need for both the funds themselves as well as their external asset managers to generate higher returns.

In the coming decade, a greater focus on emerging markets such as India is inevitable. While theoretically the expansion into emerging markets such as India is a no brainer and significant activity has been shown by large foreign pension funds to invest into the Indian markets, the game-changer will be the capacity for medium sizes as well as relatively small pension funds to invest in India. In other words, unleashing a much larger pool of capital towards the emerging markets will probably be an essential component of the strategy that pension funds from the developed markets adopt to generate returns commensurate with the investment return targets.

While the developed economies contend with underfunded pension funds, countries such as India face the issue of a funding gap between the investment available and capital required to create the requisite infrastructure for a relatively young country. The funding gaps and matching investor interest with projects assume great significance in an Indian context. While the funding gaps in infrastructure in India attracts significant attention, nowhere is the need for capital more urgent than in urban infrastructure.

With a current urbanisation rate of 34 per cent (according to the World Bank figure) and still significant urbanisation yet to come in the coming decade, India must create a policy climate to boost urban infrastructure investments significantly.

Bridging the two “funding gaps” will be challenging, but it also presents an immense business opportunity. As urbanisation escalates in India, opportunities will arise in all primary and ancillary industries related to the urban infrastructure needs including, but not limited to building materials, transportation equipment makers, energy distribution businesses, water management, sewage management and the like. Business opportunities will also arise on the capital management side, especially the asset management business. The ability to channel capital from the investors to the investment opportunities will be what will differentiate the truly successful emerging market asset managers from the crowd in the coming decade.

As we transition into a new decade, solving for structural issues that can help channel more and considerably more amounts of capital into emerging urban infrastructure requiring markets such as India have to be both the focus and the business opportunities. Regardless of the decade, the one investor requirement that will be a constant is the requirement for high risk-adjusted returns. De-risking investment opportunities will be precisely where India will have to focus through deft policy changes as we traverse the coming decade.