It is an honor and privilege for me to give this keynote speech on the occasion of the RFKennedy Compass 2016 East Coast Conference. I am particularly delighted to be speaking at an event hosted by the Robert F Kennedy Human Rights given the laudable work you do to promote a just and peaceful world. Our missions are complimentary given that the World Bank’s mission is a world free of poverty.
I am also pleased to be associated with a gathering that attracts asset owners and managers that value investment approaches that consider the impact of human rights, corporate governance, and environmental issues on investment returns.
Given the purpose of this conference and the unique challenges of our time, I thought that the theme of my remarks should be ‘Partnering with the World Bank for a Just & Peaceful World’. I will first share highlights of how we are responding to the challenging operating environment for asset management. I will then briefly present the global challenges of our time and then cover opportunities for us to partner to tackle them.
The current macro environment of slow economic growth, low inflation, and low interest rates along with demographic headwinds and on-going balance sheet deleveraging, is presenting challenges for investors. Consequently, many investors expect less generous returns in the coming years. We too expect the returns on many of our portfolios to be lower than what we have achieved historically. For our well-diversified multi-asset class portfolios where we have earned real returns of 4%-5% or more over the last 25 years, we now expect real returns in the 3%-4%.
We currently manage about $150 billion of global high quality fixed income asset portfolios for the World Bank Group, central banks, SWFs, and national pension systems. We also manage $22 billion for the WBG post-retirement benefit plans.
Diversification across a range of asset classes and risk factors is a critical component of the construction and implementation of the portfolios that we manage. This is even more apparent for the post-retirement benefit plans which are invested in a highly diversified manner across equity strategies – public and private, real assets, fixed income, and absolute return strategies.
Because of the low interest rate environment that we find ourselves in, we have been searching for alternative ways to add return to our portfolios without materially changing the risk characteristics. This has meant focusing on many of the alternative spaces where we believe we can generate the best returns going forward. We have increased our allocation to real assets, absolute return strategies and to “opportunistic investments”. And we are steady investors in private equity.
In real assets, we have invested more than $3 billion in global infrastructure and real estate, including real estate debt strategies. Our absolute return portfolio (about $2.4 billion) is intended to be uncorrelated with many market risk factors and is expected to generate modest returns consistent with those of fixed income in a more “normal” interest rate environment. And we have been investing in private debt strategies designed to benefit from the changing regulatory landscape and the roles of historically more traditional players in the capital markets.
The post-retirement benefit plans also are signatories to the Principles of Responsible Investment (ESG). And, we have been working to integrate Environmental, Social and Governance factors in our investment process. A few examples of the work that we have been doing recently include
Developing a comprehensive ESG due diligence framework designed to understand our manager’s ESG-related policies and beliefs, their ability to integrate and manage material ESG-related factors, and how they approach responsible ownership.
Working to better understand our climate risks through carbon footprint analyses on parts of our portfolio.
Participating in industry forums, discussions and initiatives. For example, we recently endorsed the Institutional Limited Partners Association (ILPA) new fee reporting template to encourage greater fee transparency in private asset classes.
The weak global economic environment is compounded by the unique challenges of our time, notably extreme poverty, inequalities, climate change pressures, fragility, conflict, violence, forced displacement and threat of pandemics.
Can you believe that 800 million people or 1 in 10 people live on less than USD1.90 per day (half of what I pay for a large cup of tea at Starbucks). World Health Organization estimates that at least 663 million people lack access to safe drinking water. Another 1 billion lack access to all-weather roads, cutting them off from access to basic health, education, trade, and employment opportunities. Around 1.2 billion people still don’t have access to electricity, according to the International Energy Agency. It is also estimated that 2.5 billion people lack adequate sanitation while 4 billion people (60% of the world’s population) still do not have access to the internet.
Climate change could push an additional 100 million people into poverty by 2030, if no action is taken to build resilience. At 65 million, the number of forced displaced persons, is the highest since record keeping started after World War II.
We believe that these global challenges must be tackled with a sense of urgency and that our twin goals of ending extreme poverty and boosting shared prosperity propel us to do our own bit. I am equally propelled by the words of Robert Kennedy – “I believe that as long as there is plenty, poverty is evil’. This is more so when as noted by Oxfam earlier this year, 62 people own the same wealth as half of the world’s population.
The World Bank Group aims to achieve its twin goals by: (1) promoting sustainable and inclusive growth, including through boosting investment in infrastructure; (2) investing in human capital, because better skills, education, health and training will make the biggest difference to a countries’ ability to grow and compete; and (3) fostering resilience to global shocks and threats.
We believe that climate change is a threat to our mission and have since the Paris Climate Accord in December 2015 been working with countries to assist them with delivering on their national climate action plans. Our own Climate Action Plan establishes ambitious targets to be met by 2020, including helping countries add 30 gigawatts of renewable energy – enough to power 150 million homes, early warning systems for 100 million people, and climate-smart agriculture investment plans for at least 40 countries. The WBG also has committed to increase climate financing from 21% to 28% of its portfolio by 2020, which means a potential $29 billion a year by 2020. We have been at the forefront of developing innovative capital market solutions to address climate change. The World Bank and the International Finance Corporation are among the world’s largest issuers of green bonds. Green bonds are a powerful source of private sector led climate finance. The World Bank issued its first green bond in 2008 and has now issued $9.1 billion in over 125 bonds and 18 currencies, including bonds tailored to specific investor demands such as issuing ESG-focused equity index-linked green bonds. Collectively, the WBG has issued $15 billion in green bonds.
Other examples include the Pilot Auction Facility for Methane and Climate Change Mitigation and the work that we do for the Adaptation Fund. We also partner with insurance companies and other entities to develop disaster risk financing for emerging markets by executing or arranging risk transfer transactions, including weather hedges for Malawi, issuance of catastrophe bonds that provide reinsurance to the Caribbean Catastrophe Risk Insurance Facility, and a Multi-Cat Program that gives governments access to insurance against natural disasters.
We have also designed innovative instruments to tackle other global challenges. For example, the pandemic emergency financing (PEF) facility which was launched at the G7 meetings in May 2016, will enable a rapid response to shut down a severe outbreak before it becomes a pandemic. This was a major lesson from the Ebola crisis that caused severe human and economic losses for Guinea, Liberia and Sierra Leone. We also structured concessional financing facilities to support middle-income countries such as Jordan and Lebanon that have hosted millions of refugees and seen severe pressures on their public services and infrastructure.
We believe investing in emerging Market infrastructure is key to restoring a growth trajectory for the world economy because developing economies have accounted for more than 80 per cent of global growth since the start of the global financial crisis. According to the World Bank’s June projections, growth in emerging markets will exceed the global average by more than 30 percent in 2016. It is estimated that the infrastructure spending needs of emerging market countries, that together account for almost 60% of the World’s GDP, is roughly USD$1.5 trillion per year over the next decade. Clearly, the sums involved are enormous. But at the same time, the amount needed for infrastructure represents less than 2% of the total global bond market, which is estimated to be roughly US$100 trillion in size. It also represents less than 1% of the US$200 trillion that McKinsey estimates as total assets held by institutional investors and banks.
The critical importance of infrastructure development to combat poverty and promote equitable and sustainable economic growth certainly has not been lost on the world community, as infrastructure features very prominently in the Sustainable Development Goals, or SDGs. Building on the successes of the Millennium Development Goals, the seventeen SDGs were adopted in September 2015 by countries from around the world. Achieving these goals by the target date of 2030 will depend largely on the success we have mobilizing more financing for infrastructure. In fact, SDG number 9 is specifically on infrastructure. In addition, achieving many of the other SDGs, from clean water to clean energy to creating more sustainable cities all depend on infrastructure development. Emerging markets, by incorporating clean energy and green financing as core pillars of their infrastructure build-out have the potential to leapfrog the rest of the world.
The World Bank Group engages on multiple fronts – ranging from traditional financing to technical assistance to knowledge sharing. We also offer the private sector a pipeline of well-structured, investable projects. We recognize that we must innovate and reduce the approximately 70% of multilateral development bank support for infrastructure that has come in the form of senior loans. Multilateral development bank balance sheets are a precious resource and need to be treated as such by leveraging relatively small and targeted amounts of financing or guarantees in order to mobilize large amounts of private investment.
One example of this is the support we were able to provide for the Sustainable Transport project in the state of Sao Paulo in Brazil. Committing $300 million on a $729 million project in 2014, the Bank was able to mobilize additional funds through the private sector by offering a credit enhancement against non-payment by the state through MIGA.
Another example is the Global Infrastructure Facility (the GIF). Established in April 2015 with an initial capital of $100 million, the GIF was created by the Bank to facilitate the preparation and structuring of public private partnerships. An open platform, the GIF seeks to mobilize capital to spur infrastructure development by coordinating the efforts of multilateral development banks, governments, and the private sector. Representing about $12 trillion in assets under management, GIF’s partners work together to unlock even greater amounts of capital to build a global pipeline of sustainable infrastructure investment projects.
Another World Bank initiative, the Public Private Infrastructure Advisory Facility, partners with other donors, multilateral development agencies, and international financial institutions to provide technical assistance grants to governments to catalyze private sector participation in emerging market infrastructure. For instance, the Facility’s support was instrumental in enabling a state in India to scale-up renewable energy and catalyze the development of a 1,000 megawatt solar park through PPPs.
We also provide guarantee programs to cushion a variety of stakeholder risks, lengthen tenors, and lower financing costs. For example, last year (2015) our board approved a unique combination of two guarantees for Ghana’s Sankofa Gas Project – a (IDA) payment guarantee of $500 million that supports timely payments for gas purchases by Ghana National Petroleum Corporation and an (IBRD) Enclave Loan guarantee of $200 million that enables the project to secure financing from its private sponsors. Together, the guarantees are expected to mobilize $7.9 billion in new private investment for offshore natural gas, representing the biggest foreign direct investment in Ghana’s history. Developing the Sankofa Gas Project – located 60 km offshore – is expected to bring significant benefits for Ghana by fueling up to 1,000 megawatts of clean power generation, replacing polluting and expensive oil-burning electricity. Once the Sankofa field starts to produce gas in early 2018, Ghana will be able to reduce its oil imports by up to 12 million barrels a year and cut carbon emissions by 1.6 million metric tons of CO2 annually.
A recent transaction we think can serve as a model for how multilateral development banks and the private sector can work together is the Managed Co-Lending Portfolio Program (MCPP) which was arranged by IFC, working with the Swedish International Development Agency. This structure allows institutional investors, such as insurance companies, to set up vehicles to co-invest in a diversified pool of IFC infrastructure loans. When IFC provides debt financing to infrastructure projects, it will offer a portion of the new loan, on a participation basis, to each vehicle, and IFC will credit enhance the participations by retaining a 10% first loss position. In turn, the Swedish International Development Agency will provide a guarantee to IFC that will cover a portion of that first loss position. The MCPP offers institutional investors the ability to participate in IFC’s future senior loan portfolio with an initial $5bn target. MCPP Infrastructure loans have a low investment-grade rating and yield 400 to 450 basis points over LIBOR.
Indeed, emerging market infrastructure does not only offer diversification opportunities but also offers good returns. For example, since the start of this century, IFC has delivered returns above 20% a year on average on its equity investments in emerging market infrastructure. (“An extra $1tn a year for emerging market infrastructure”, FT, 2015) Default rates are comparable to those of developed markets. It is also important to note that the landmark Paris Climate Accord which was ratified by global leaders earlier this month, and a month ahead of schedule will encourage clean infrastructure investments. By investing in EM infrastructure, you will not only enhance your portfolio’s Sharpe ratio but also meet your ESG criteria and be a good corporate citizen.
We have also leveraged our experience and expertise in and access to capital markets to develop solutions to spur infrastructure development in emerging markets. For instance, in response to growing interest from asset managers and institutional investors seeking to invest in this asset class, we recently partnered with Morningstar to develop a fully investible EM infrastructure bond index. The Emerging Markets Infrastructure Debt Index (EMIDI) would serve as a benchmark, and possibly the basis for a variety of investment products, such as exchange-traded funds and mutual funds.
Back-testing of the proposed index shows that, over a five year period, it has delivered returns well in excess of 400 bps with almost the same standard deviation as the Barclays Global Aggregate Total Return Index. A debt index like this has the potential to promote liquidity and allow institutional and retail investors insight and access into the EM infrastructure space. This will further complement existing equity-based indices such as S&P’s Emerging Markets Infrastructure Index.
The common thread through all of these initiatives we are working on at the World Bank Group is a focus on finding ways to mobilize private sector investment. The diversification and return opportunities for investors in emerging market infrastructure are equally clear. We are in the middle of an unprecedented and global savings glut, which together with weak growth in the developed world, has led to historically low interest rates. Emerging market infrastructure, with its potential for higher returns is a natural candidate to soak up some of this excess liquidity. Infrastructure assets have the potential to deliver long dated cash flows with attractive yields and significantly less volatility than equity investments
Studies have also shown that, in reality, emerging market infrastructure is less risky than many investors commonly perceive. According to Moody’s, for example, while default rates on project finance loans are slightly higher in emerging markets than in the OECD countries, the recovery rates were almost identical. Therefore, the risk adjusted returns on emerging market infrastructure are actually quite compelling, even when compared with developed market infrastructure assets.
Infrastructure holds enormous potential in fueling economic growth across emerging markets. This is particularly important given the fragility of the world economy and the role of emerging market countries as engines of global growth. With historically low interest rates, deflationary pressures, and quantitative easing, infrastructure is indispensable for long term global growth. As asset owners and asset managers, we have a unique opportunity to mobilize public and private financing to support infrastructure and kick start the global economy. At the World Bank Group, we are delighted to partner with you as together, we can do well and do good.
In Robert Kennedy’s Ripple of Hope Speech, he enjoined us to “act to improve the lot of others”. I quote, ‘It is from numberless diverse acts of courage and belief that human history is shaped. Each time a man stands up for an ideal, or acts to improve the lot of others, or strikes out against injustice, he sends forth a tiny ripple of hope, and crossing each other from a million different centers of energy and daring those ripples build a current which can sweep down the mightiest walls of oppression and resistance.’