UK pension funds came late to the last infrastructure investment party. The Australians and Canadians had been popping champagne corks since the 1990s as their vast funds reaped the benefits of holding large portions of valuable assets both at home and abroad.
Unbeknown to them, when UK funds raised the capital to turn up fashionably late around 2005 and 2006, ‘subprime mortgage’ was about to become an everyday word. Before they knew it the music had died out and they found themselves picking up empty bottles.
But there’s always another party to go to. And ever since George Osborne’s call for pension funds to help drive the revitalisation of the UK’s energy, housing and transport networks back in 2011, the awareness and acceptability of infrastructure as a viable investment has been steadily growing within trustee boards and in-house investment teams.
Part of this willingness to seriously investigate the asset class has been driven by a desire to protect against both deflation and inflation. The other main driver has been the prospect of securing exposure to longer-dated income producing assets that match liabilities while providing attractive returns.
The numbers have reflected this positive response. An NAPF report released last summer, which covered allocations within private sector defined benefit (DB) schemes, showed a marked rise in infrastructure investments, with open plans and those still open to accrual having, respectively, a 2.1 per cent and 1.1 per cent average share of the asset class.
The public sector has also committed more funds to infrastructure and has been given the green light to continue on that path, with the Department for Communities and Local Government raising the limit for local government pension funds’ (LGPS) investment in limited partnerships from 15 per cent to 30 per cent last year.
Further momentum has come in the form of the NAPF’s Pensions Infrastructure Platform (PIP), combining the financial might of pension funds such as BAE Systems, BT, the Pension Protection Fund and the Railways Pension Scheme.
It is hoped that the PIP will be able to flex the sort of muscle that has allowed Australian superannuation funds and Canadian pension behemoths to vacuum up valuable assets in the UK and in Europe.
The University Superannuation Scheme has already led the way with its recent forays into the asset class. It took up a 49.9 per cent interest in an Australian public transport company late last year, after having taken a stake in an air traffic management company, as well as the company that owns Heathrow Airport Holdings.
Spoilt for choice
With the mechanisms being put in place to increase investment, the government has responded by recently unveiling its National Infrastructure Plan, aimed at raising £375 billion for various projects running until at least 2030.
And as Morgan Stanley head of Asia Pacific Infrastructure Mark McLean points out, opportunities will not be limited to the UK.
“The fundamentals underpinning demand for infrastructure remain strong, so there’s going to be lots of opportunities to buy assets - and there will be an increasing number going forward,” he says.
“It just makes a lot of sense, given the amount of infrastructure that needs to be built around the world and the fact that most governments these days are cash-strapped should see an ever-increasing number of assets that are getting privatised.”
Examining the options
As the NAPF’s numbers would suggest, most UK schemes have some indirect exposure to infrastructure and it’s usually in the form of corporate bonds or utility company equities.
But to truly benefit from the asset class’ qualities, further exploration is needed, opening up some soul-searching questions for trustees.
Aquila Capital managing director Stuart MacDonald says that funds looking to truly harness the benefits of infrastructure need to carefully identify which strategies generate the performance - and contain the type of risk – that they want to take onboard. But that can take considerable time.
“While a lot of people have got their head around the fact that one can capture a whole bunch of illiquidity premia and play around with portfolio duration, one of the crucial things is that the underlying infrastructure investment is such a broad term,” says MacDonald.
“So it’s rather like when people say that hedge funds are performing well, not so well or somewhere in the middle at any given moment in time. What’s the meaning of looking at a broad aggregate like that? It doesn’t tell you anything.
“People are getting interested and beginning to distinguish between types of infrastructure, whether it’s some type of PPP bond to do with transport or renewable energy, or agriculture.
“We’re talking about things that behave entirely differently to each other.”
Social responsibility can come into play when looking at infrastructure as well, particularly when searching abroad, adds MacDonald.
“In what way is one going derive profit? From intensive farming that’s going to use up scarce resources?
“Or are you going to take the view that the place you invest in has to be in better shape when you leave it than when you entered it?”
Once a scheme has its head around where it wants to go, however, it may still find that its options are somewhat stymied, simply due to its size.
As Redington head of manager research Pete Drewienkiewicz says, larger pension schemes can access the market relatively easily via segregated mandates.
“However, for small- to medium-sized schemes, it is quite difficult to invest in a pooled format at present,” he explains.
But they may not have to wait too much longer. There are some pooled funds in the late stages of development, which Drewienkiewicz believes will soon give smaller schemes a suitable way to gain access.
Private equity-style infrastructure funds are another option, but Drewienkiewicz cautions against their use.
“Are they really aligned to the interests of most pension schemes?” he asks rhetorically.
“These funds invest in very stable assets that can deliver a 6 to 7 per cent yield for 30 years, for example. This type of asset can be a good match for liabilities. But you don’t necessarily want to sell it off after say, 10 years – in other words, the maturity date of the vehicle.
“And when you add leverage, and high fees, the returns can be disappointing and far more volatile than expected. This is why we generally stay away from this type of vehicle,” he says.
Given the number of considerations that have to be made with infrastructure, it may be some time until the UK lets its hair down and really throws itself back into the party.
When they do, they’ll be hoping that it lasts a bit longer this time around.
Marek Handzel is a freelance journalist