The Rise of the Institutional Investor

Financing is the lifeblood of an economy. Take it away, and the wheels turn very slowly…or not at all. Compromise it, and the negative effects are widespread. The world has lived that since the Great Recession. Some of the world’s best-known banks faced an asset meltdown that threatened their viability. At the same time, the startling prospect of bailing out their extensive global operations fell to their country alone – which in more than one case would have been greater than the country could handle. Small wonder there has been a concerted effort across the developed world in the recession’s aftermath to shore up the financial system. Are things getting put back together?

Slowly but surely, yes. Regulation has been the main response, and Canadians have figured prominently in various key efforts. In general it seems that financial sector innovation overtook the capacity of regulation to oversee it, meaning that something of a giant catch-up was needed. Thus far, it is obvious that there has been something of a pull-back from further-flung operations, and a greater aversion to long-dated transactions. Regulators seem happier with business that’s closer to home, and the stuff that doesn’t stretch too far out onto the horizon. European financial institutions, known for their global operations and their involvement in long-term financing across a variety of industries, in this neo-regulatory phase are pulling back from this space, creating a vacuum of sorts.

Enter institutional investors. Made up largely of large insurers and pension funds, as a group these are well-heeled organizations with boatloads of capital to deploy. Low returns on fixed income, a reality brought on by the ultra-loose monetary policy, have created a problem for these massive funds at a most inopportune time. Insurers are faced with a series of unusual weather, seismic, geopolitical and other events requiring in some cases pretty massive payouts. All pension funds are grappling with the need to finance the ageing of the population, and many across the planet face serious underfunded liabilities.

A key solution to both problems is a higher long-run rate of return. This need, coupled together with global opportunities, has fueled an appetite among institutional investors for a broader range of assets. In fact, this is occurring in tandem with the movement of the banks out of some of these asset classes. Institutional investors, among them key Canadian funds, are far more active in global real estate plays, infrastructure, private equity deals and infrastructure projects.

A particular advantage of the institutional investors is that their capital pools are patient – in a world that is increasingly looking for quarterly results, the institutional world takes the long view, and can weather short-term disruptions or investment plays that don’t have an immediate payoff. In effect, opportunities that have a long and lucrative payback horizon might be shunned by traditional financiers, but in many cases represent some of the best 10- to 20-year returns available. It enables them to sidestep the volatility – in product flow, currencies, interest rates, equity values – that has become too prevalent in recent years, concentrating instead on the core business case for a wide array of global projects.

This is good news for those with more of a global business mindset. Plans might make perfect sense, but without a source of financing, they are unlikely to see the light of day. Awareness is essential, though; the shifts in financing sources could well discourage those looking for financing in more traditional places. Taken to its limit, this could actually have a detrimental effect on the long-term thinking that is essential to creating and implementing next-generation projects, products and technologies. Thankfully, traditional players seem to still have skin in the game, involving themselves in originating deals, and then packaging them out to other financiers. Managed well, this should help to smooth the transition in financing providers. Done poorly, it threatens to produce 2008 all over again.

The bottom line?

Sources of financing aren’t drying up, they are just shifting – and to a segment of the industry in which Canada has several key global players. In the coming cycle, financing solutions are going to be as critical as product solutions, so it’s great news that Canada is in the picture in a big way.

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