In a bid to attract foreign investment to fund National Democratic Alliance (NDA) government’s ambitious Rs 103 lakh crore National Infrastructure Pipeline, Union Finance Minister Nirmala Sitharaman, during her Budget 2020, unveiled major tax concessions on investments by sovereign wealth funds (SWFs).

She proposed to grant 100 per cent exemption on interest, dividend and capital gains income on investment made by SWFs in infrastructure and other notified sectors either in the form of equity or debt. The timeline for availing this benefit has been fixed at 31 March 2024, with a minimum lock-in period of three years.

The proposal later notified in the Finance Bill laid out a host of criterions for SWFs to avail this tax benefit including

1. Wholly-owned and controlled, directly or indirectly, by the government of a foreign country; set up and regulated under the law of a foreign country;

2. The earnings of the fund are credited either to the account of the government of that foreign country or to any other account designated by that government so that no portion of the earnings inures any benefit to any private person;

3. The asset of the fund vests in the government of such foreign country upon dissolution;

4. The fund does not undertake any commercial activity whether within or outside India.

BloombergQuint quoted Bhavin Gada, a partner at law firm Economic Laws Practice, as saying that SWFs like GIC Pvt Ltd, Kuwait Investment Authority, Temasek Holdings, Alaska Permanent Fund Corporation, Hong Kong Monetary Authority Investment Portfolio and SAFE Investment Company would benefit from the tax exemptions if they meet the eligibility criteria.

In a paper by Caroline Nowacki and Ashby Monk of the Global Projects Center, Stanford University titled “Sovereign Wealth Funds Investments In Infrastructure”, the authors provide insight on the growing interest of Sovereign Wealth Funds in infrastructure investments, primarily driven by expectations of stable, predictable cash flows, superior returns to bonds, and low correlation with the market.

Following are edited excerpts from their paper.

Why Sovereign Wealth Funds Are The Best Bet For Greenfield Infrastructure Funding

Pension funds, insurance companies and SWFs have been identified as “long-term investors” because of their long-term horizons (compared to the usual five years of a mutual fund) and large assets under management. This long-term horizon means they could reap an illiquidity premium by investing in assets that will bring superior returns beyond the traditional five-year horizon of most mutual funds.

Institutional investors are attracted to infrastructure for their promise of stable, long-term cash flows and portfolio diversification. These characteristics have been particularly attractive to pension funds and insurance companies, whose portfolios were badly impacted by the financial crisis and subsequent low-yield environment.

Pension funds have consistently been at the forefront of expressed interest for infrastructure. However, most pension funds and insurance companies prefer the stable investment profile of existing, operational infrastructure assets, and only opportunistically invest in new infrastructure projects, for which construction, political and demand risks exists. Regional preference also overwhelmingly goes to Europe and North-America, as emerging markets’ political instability and financial market volatility shy these investors away.

These preferences of pension funds etc, contribute to the lack of capital for new projects and in emerging markets, which would have the most beneficial development impacts and are highest on governments’ priority list.

It is in this context that SWFs offer an alternative as their investment preferences do not align with mainstream infrastructure investors’: they invest both in developing and developed markets, greenfield and brownfield.

The proportion of SWFs investing in infrastructure has increased, going from 56 per cent in 2012 to 63 per cent in 2017. The total amount invested by SWFs also grew as the assets under management of these funds increased from 3.07 trillion in 2007 to 6.59 trillion in 2017. According to a survey of fund managers, SWFs occupy the fourth place in interest growth for infrastructure, behind public pension funds, private sector pension funds and insurance companies.

SWFs’ large amounts of assets under management, long-term horizon, and less strict requirements in terms of paybacks to beneficiaries, can give them an advantage over other infrastructure investors. The development mission of some SWFs also contributes to making greenfield infrastructure attractive to them.

SWFs’ geographic preferences are well balanced. In 2015, 55 per cent of them were investing globally, 50 per cent preferred Europe and Asia, 48 per cent preferred the Middle East and North Africa, and 41 per cent declared a preference for North America. In 2017, 43 per cent of SWFs surveyed by Preqin preferred to invest in emerging markets.

SWFs are willing to take country risks to benefit from prospective excess returns, higher growth, diversification from developed markets, and to find deals with less competition, which currently drives up the price of assets in developed countries. Most SWFs are also located in Asia and MENA region and can have an advantage over foreign investors in these regions, as well as a domestic development mandate.

Almost all SWFs investing in infrastructure invest in economic infrastructure, in line with their financial returns requirements.

In addition, and contrary to pension funds, SWFs invest more in greenfield (new) infrastructure than brownfield (existing) and secondary/growth stage (improvements on an existing asset) projects. Preferred industries are energy (95 per cent), transportation (86 per cent), utilities (64 per cent), water (61 per cent) and telecoms (59 per cent)

This deep dive in SWFs’ strategies for infrastructure investments leads to consider the different ways SWFs use to invest in infrastructure

SWFs’ large capital gives them a considerable advantage in internalising infrastructure investments, and their international implantation makes partnerships and co-investments a good way to access foreign markets. Investment partnerships between SWFs, other institutional investors, and asset managers are more and more common.

These partnerships can be deal-specific, longer-lasting collaborations are also emerging. Several models correspond to collaborations between long-term investors that decrease the detrimental power difference they had with asset managers: the alliance, the syndicate, asset owners investing on behalf of other asset owners, seeding new asset managers, and joint ventures.

Obstacles Faced By Sovereign Wealth Fund In Infrastructure Funding

Investors’ main cited concerns regarding infrastructure in 2016 were the too high valuation of brownfield infrastructure assets, driven up by increased competition and lack of information.

Greenfield infrastructure still presents many risks for a single asset (regulation, construction, demand) which can deter many investors. Infrastructure also lacks several characteristics to really be on par with other asset classes inside investors’ portfolio.

First, infrastructure lacks a benchmark based on performance measures that reflect the variation in infrastructure projects’ risk profile, their risk including conditional value-at-risk, and correlation between infrastructure assets and other asset classes. There are two key obstacles to building this benchmark: the lack of large samples of empirical observations, and of a unique pricing measure.

Second, infrastructure projects’ illiquidity, and the distribution of projects across many jurisdictions contribute to the lack of comparable data. The valuation of each project is also based on a net present value and is therefore discounted based on the risk preference of each investor looking at a project, thus hindering the comparability of projects.

Third, the information asymmetry and high fees of fund managers are also an obstacle for smaller SWFs. However, most SWFs now invest directly. Nonetheless, when investing directly in projects, they face the challenge of populations’ fears of political interference in assets that are vital to them.

Many countries, such as Australia and the US, have a commission assessing the potential dangers of foreign investment in critical assets, and laws often restrict foreign participation to a non-decisional position in critical assets.

China Investment Corporation’s (CIC) chief executive officer recently cited increasing protectionism and fear of foreign investment as one of its main challenges. This has led SWFs to partner with local pension and sovereign funds to calm these fears and increase interest alignment.

As an example, CIC and Abu Dhabi Investment Authority (ADIA) declare preferring minority positions with no control over the assets when investing in infrastructure in foreign countries.

Finally, populations are also wary of privatisations that bring higher prices, often without significantly improving the quality of the service. Infrastructure investors have also often been too passive in their management and they will have to bring innovation and focus on making user experience significantly better under private management to convince very reticent populations of the benefits of private management of infrastructure.

Indian Experience So Far In Infrastructure Funding Via Sovereign Wealth Funds

ADIA, the world’s third-largest sovereign wealth fund, has emerged as an active investor in India’s infrastructure sector in recent years. It invests in both publicly-listed and privately-held companies.

ADIA is one of the most active foreign investor in this country, with investments in equities, fixed income, real estate and private equity.

ADIA has notably invested $350 million in two of the country’s largest renewable energy companies, ReNew Power and Greenko. It was also the founding partner of India’s National Infrastructure Investment Fund, committing $1 billion.

ADIA plans to continue to invest even outside of the NIIF partnership, notably in minority stakes alongside aligned and reputable partners, in high-quality Indian companies. Indian companies such as GMR Airports or Cube Highways (a PE-backed platform) have also found much needed capital in partnering with ADIA on flagship projects.

In October 2019, GVK Airport Developers Limited and GVK Airport Holdings Limited signed definitive agreements with ADIA, Canada’s Public Sector Pension Investment Board and Indian government-backed National Investment and Infrastructure Fund (NIIF).

Another prominent sovereign wealth fund that actively invests in India is Singapore’s GIC Pte Ltd. GIC has invested in Greenko and several other infrastructure companies.

This piece was first published on Indiainfrahub, and has been republished here with permission.

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