Demand for infrastructure investment continues to ramp up amid growing commitments to a low-carbon future and rapid economic growth in developing countries. The nature of this “scaling up” challenge requires capital that governments cannot provide alone, necessitating the utilization of private capital. Institutional investors collectively possess the financial resources ($16 trillion in “direct” investment capacity) to fill the gap.1 Infrastructure assets seem to be a natural match for many institutional investors: the asset’s long-time horizon meets the long-dated liabilities of asset owners. But despite a growing need for investment and a mutual affinity for collaboration, private infrastructure investment figures have remained stagnant for almost a decade. Governments struggle to tap private capital on long-term projects, especially in developing countries where it is needed most. We believe a “structural hole” exists in today’s capital marketplace, which can only be remedied through aligned coordination between the government, asset owners, and industry to successfully mix public and private capital.
Sovereign development funds (SDFs) and strategic investment funds (SIFs) have emerged as promising models to channel large volumes of institutional capital into national investment priorities, such as infrastructure. The International Monetary Fund (IMF) defines SDFs as a subclass of sovereign wealth funds (SWFs) that “help fund socio-economic projects or promote industrial policies that might raise a country’s potential output growth.”2 While SDFs are only a small subclass of the greater SWF community, their popularity has grown in recent years. When set up properly, an SDF can be a powerful tool to fuel local economies, accomplish strategic goals, and scale climate investment by bridging institutional capital with public projects. More specifically, we believe the focus of these funds on earning market returns makes them more successful in achieving desired development goals.
Top-performing SDFs often utilize four different operating goals: 1) reinforcing underperforming national assets, 2) crowding in private investment, 3) catalyzing new industries, and 4) financing domestic industries. One critical characteristic of these funds is their ability to make independent investment decisions. While these funds are linked to their government sponsor, “arms-length arrangements” allow for independent governance and a focus on investing in financially viable projects. Furthermore, the goals of SDFs are often multi-tiered. A “mandate” exists at the top, followed by a regional or sectoral specialization and functional specifications at the bottom. This tiered prioritization of directives allows SDFs to have strong governance and versatility. The ability to innovate and flex seems to be a key competitive advantage for these funds.
Funds specializing in crowding-in private investment and foreign capital towards strategic projects are known as ‘strategic investment funds’ (SIFs). Plan sponsors often use SIFs to rapidly accelerate economic diversification, especially in countries with underdeveloped industries or resource dependencies. To successfully attract long-term investors (LTIs), SIFs structure themselves in a way that aligns both parties’ interests. The Collaborative model, which combines other popular models such as the Endowment model and Canadian Model3, provides a blueprint structure that SIFs can utilize to help achieve alignment of interest with LTIs. The Collaborative model acknowledges that certain private market assets (such as infrastructure and development projects) match long-term investment strategies, that direct investing is more cost-effective, and that alternative investment managers are required, but their governance must be redefined to achieve more alignment. SIFs are best characterized by this collaborative investment model.
A SIF’s mandate to develop strategically must not distract from its ability to invest effectively. Investment prioritization is critical to a successful SIF. Internal capacity for strategic decision-making must be developed by staffing the fund with seasoned investment professionals. Developing policy expertise further arms the SIF, allowing it to counsel the government on investment and policy priorities, promote new initiatives, and create a wide network of partnerships. This dual policy and investing role enables SIFs to unlock key domestic policies and a favorable investment landscape. SIFs can leverage their proprietary knowledge of market conditions, relationships with government and SWFs, and privileged access to investment opportunities to develop unique investment abilities that lead to cumulative returns. By internally controlling the investment process, SIFs can build a “positive feedback control loop” that generates structural “alpha.”4 Doing all of this, however, demands well-structured governance that attracts capital. It is imperative that SIFs adopt an independent, commercial focus that is executed by management with a strong investment track record.
To more deeply examine how the governance structure of SIFs impacts outcomes, our research team examined the National Investment and Infrastructure Fund of India (NIIF). The NIIF was created in 2015 by the Government of India as a SIF to translate capital from international and domestic investors into infrastructure and allied sectors in the rapidly growing Indian economy. The Indian government committed about US$3 billion to the NIIF and designed it to be the largest infrastructure investment vehicle in India. As of 2022, the fund has brought in more than US$7 billion in sovereign investment from SWFs or similar vehicles (SWF 2022). The NIIF’s mandate is especially interesting, because it does not pursue a double bottom line of generating investment returns and driving domestic development. Instead, it exclusively seeks attractive investment returns in infrastructure and adjacent structures. By maximizing financial performance, this strategy inherently delivers maximum development impact.
The NIIF utilizes independent, “arms-length” governance to fully emphasize commerciality. First, NIIF Limited was set up as a company, not a state-controlled agency. The Indian government only owns a 49% stake, making the collective of investors the majority shareholders. As for the governing board, there is no representative from the Indian government on the actual Investment Committees. Each fund under the NIIF is composed of a team of executives and independent members, accompanied by an Advisory Board with investor representation, all in accordance with global best practices. But the government still maintains oversight through the Governing Council chaired by the Indian Minister of Finance (which meets once a year to provide guidance to the NIIF) and two seats on the NIIF board, which oversees operations. This arrangement allows the government to maintain oversight and assist the NIIF but removes politics from the NIIF’s commercial decision-making process.
The flagship fund under the NIIF utilizes the collaborative investment model (Reference – REFRAMING Finance). The fund is investor-owned and employs investment platforms that support direct, aligned partnerships with developers and asset managers and provide co-investment rights to existing and potential investors. The direct, aligned, and long-term framework is extremely popular with institutional investors. The first flagship fund raised US$2.34 billion (well over the initial target). The NIIF also fundraises in an innovative and effective way, using the Ministry of External Affairs to make introductions on behalf of the NIIF to foreign SWFs and pension funds.
The NIIF also capitalizes on its relationship with the government to achieve investment success. The NIIF features a Strategic Initiatives and Policy Advisory (SIPA) team with a wide variety of objectives. They specifically focus on utilizing the government to solve investment-related policy issues, originate investing opportunities, create multiple platforms to nurture India’s investment ecosystem and conduct deep market research. But they also aim to attract capital, champion new internal initiatives around the NIIF, drive innovation, enhance international visibility, and more. SIPA is having a marked impact. They have provided actionable thought leadership in new infrastructure areas and led global infrastructure task forces. Domestically, SIPA has created investment deals, connected international investors and the Indian government, and advised India’s National Infrastructure Plan, ultimately leading to several projects with existing and new infrastructure assets.
This case offers a resounding reinforcement of the promise of SIFs. The NIIF has effectively connected capital-starved assets with institutions looking for attractive long-term investments. The model is critically defined by its commerciality, independence, and collaborative alignment. It is further aided by the SIPA team, a major competitive advantage for the fund. SIFs can deliver economic growth and attractive returns, when designed, governed, and managed properly. SIFs are one adaptation of SDFs, specifically unlocking capital by attracting foreign investors and instituting financial discipline. The possibilities created by collaborative, direct investing and aligned synergistic governance could potentially help close the global infrastructure gap and accelerate the low-carbon transition.
Carter Casady is a Research Engineer in the Center for Sustainable Development and Global Competitiveness at Stanford University and a non-resident Senior Fellow in the Center for Transportation Public-Private Partnership Policy at George Mason University.
Rajiv Sharma is the Research Director for the Long-term Investing Initiative at Stanford and a Visiting Research Associate at the Oxford University Smith School of Enterprise and the Environment.
Ashby Monk is a Senior Research Engineer, School of Engineering at Stanford University and holds the position of Executive Director of the Stanford Research Initiative on Long-Term Investing.
This post was adapted from their paper, “The Keys to Sovereign Development Fund Success: Innovation, Collaboration & Commercial Focus,” available on SSRN and forthcoming in the Journal of Alternative Investments.