Infrastructure: How to build back better


14 Mar 2022

What does infrastructure bring to institutional portfolios? Andrew Holt finds out.



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What does infrastructure bring to institutional portfolios? Andrew Holt finds out.


Everyone loves infrastructure, especially the government. Indeed, in 2020 the chancellor, Rishi Sunak, set out the UK’s first infrastructure strategy. This was followed almost two years later with the Levelling Up whitepaper, which has infrastructure scribbled all over it, like a lovelorn teenager. Institutional investors, particularly pension funds, also love the asset class for a host of reasons.

But for all this love, the biggest challenge associated with infrastructure is the simplest and the most obvious: the lack of appropriate projects to invest in. How can something so loved be so elusive? The government has a major role here, possibly becoming an effective infrastructure-dating agency, so investors and projects can meet their ideal match.

“Government intervention is the most likely and most significant catalyst to increase the number of investable greenfield projects,” says Paddy Dowdall, assistant executive director of the Greater Manchester Pension Fund, citing one area that is no doubt the future of infrastructure (see boxout, Infrastructure: Going green). “This could be in the form of direct procurement of social infrastructure, renewable energy subsidies-price certainty grants for brownfield re-development, or co-investment on a subordinated basis,” he adds.

Sarah Gordon, chief executive of the Impact Investing Institute, agrees, noting that while the government has encouraged institutional investment, it could, and should, extend its work further to focus on impact investing. “We believe they [the government] can go one step further by using public investment to catalyse institutional investment in historically under-served regions of the UK.

“Alongside helping to crowd in investment, government can also empower people and communities in these places to engage with private capital,” she adds.

New technology

Michele Armanini, greenfield managing director of Infracapital, M&G’s unlisted infrastructure equity business, concurs. He highlights several areas where the government needs to do more to make projects viable to institutional investors, with the emphasis on new and innovative initiatives.

“When it comes to encouraging institutional investment into sustainable infrastructure projects, the government and regulators must embrace new technologies in a way that enables them to scale quickly and share risk fairly across the public and private sector,” he says.

On a positive note, Armanini has seen examples of this, with the UK government’s development of effective models, such as Contracts for Difference, to support and incentivise investment in sectors like offshore wind. “This level of support and targeted intervention has dropped off substantially, and private sector investors can now invest in this sector with confidence, knowing they can make an economic return and will not be left with stranded assets,” he adds.

George Graham, director of South Yorkshire Pensions Authority, argues there are other ways of shifting the infrastructure needle. “The key change that would improve matters here is to find more ways to bring the skills and expertise of fund managers together with the people running projects and to create some template projects that can be replicated fairly easily, from say, one district heating scheme to the next.”

It is also a more complicated picture, presenting other challenges. “For UK investors in UK projects, the challenge is often competition from overseas investors with deep pockets,” Graham says. “This is great for the projects, not necessarily good for us as an investor.”

In addition, Graham adds: “An increasing challenge, as the definition of infrastructure broadens, is projects lacking scale and needing significantly more work to be investable.” For Graham, there are other ways the government can try to improve the situation. “It can maintain a consistent policy stance and reducing the time to get projects out of the planning stage would help greatly,” he says.

Transition investment

Nest’s chief investment officer, Mark Fawcett, offers a different perspective on the lack of infrastructure projects narrative: “We disagree,” he says. “If we consider the investment required to transition the world to a low carbon economy, then it is clear there are plenty of projects coming down the track. Also, with government debt across the world at heightened levels due to the pandemic, we should expect private capital to be in demand for a wide range of infrastructure investments.”

Offering another perspective, Ted Frith, chief operating officer at investor GLIL Infrastructure, points to the influence of renewable energy on the issue. “It’s not that there aren’t plenty of projects out there, but the increased focus on areas such as renewable energy, has made many a lot more competitive,” Frith says.

“The infrastructure market has attracted a large amount of capital looking to invest in these sectors, which in turn drives up the price,” Frith adds. “Investment opportunities have always relied on a range of factors lining up at the same time, but right now you need to work harder and be smarter to find the projects that are appropriate, accessible and provide diversification for the fund.”

And Armanini adds: “It’s true that there has been a growing appetite for infrastructure assets, but we equally have seen a proliferation of investment opportunities, driven by macro trends such as digitalisation and the drive to net zero.”

This in turn brings opportunities, Armanini says. “In Europe, where our investment activities are focused, there is an estimated €650bn (£544bn) of additional investment required per year by 2030 to fund the green and digital transitions, the European Economy Commissioner says. With public funds stretched following the Covid-19 pandemic, the private sector has a vital role to play in meeting these funding requirements.”

Project pipeline

Pension funds are being proactive in this area, including the South Yorkshire Pensions Authority. “Our fund managers are working on larger scale renewable projects and addressing intermittency,” Graham says. “Directly, we are looking at ways to finance the bringing forward of major development sites, which includes things like the site infrastructure,” he adds. “These are all focused on providing income streams which are increasingly important given the fund’s cashflow dynamics.”

GLIL’s portfolio spans an array of projects, from renewable energy to logistics, transport, utilities and social infrastructure. “Recently, we invested in Invis Energy’s portfolio of 11 operational onshore wind farms, which provide around 11% of the Republic of Ireland’s installed wind capacity,” Frith says. “We have also doubled our equity stake in Semperian, which invests in essential local services, such as schools and hospitals across the UK.”

Frith adds an important point here. “Our fund members represent pensioners from across the country. We are, therefore, supportive of providing better opportunities and public services wherever they are needed.”

Risk reward

When it comes to the risk-reward profile of infrastructure assets, this is placed at a centre of South Yorkshire Pensions Authority’s assessments. “We would regard projects of this sort as around the midpoint of our risk exposures as the income streams are fairly secure and for more local projects where we tend to be a direct investor we tend to act as a senior lender with step-in rights which reduces exposure further,” Graham says.

“The rewards vary but the hurdle rates we use to determine which projects to consider give a margin over the actuary’s return assumption, which means we are achieving our core objective to ensure we have enough money to pay pensions,” he adds.

From a Greater Manchester Pension Fund perspective, Dowdall says: “We only make investments appropriate to our targeted return and risk tolerance to meet stakeholders’ objectives.”

For Fawcett and workplace pension provider Nest, the risk-reward picture varies. “There are core assets with stable cashflows which are relatively low risk and in contrast new projects with construction and technology risk,” he says. “While we have a focus on lower risk assets, we expect our managers to also seek out higher returns by taking construction risk with proven technologies, for example, financing construction of a new wind or solar farm.”

Frith says GLIL looks, on the whole, at core infrastructure projects. “By definition, the cashflows are much more certain than many asset classes that our pension fund investors allocate to. Therefore, the volatility of returns is expected to be low.

“However, returns are also lower than certain other asset classes, for example, private equity,” Frith adds. “At a portfolio level, investment in infrastructure can improve the risk-adjusted returns of the portfolio due to its diversifying characteristics. GLIL targets a return of CPI plus 4% to 6%.”

Diverse portfolio

For Armanini, infrastructure is about growth and impact. “Through buy-and-build strategies, our focus is on acquiring, building and managing a diverse portfolio of European infrastructure assets that can deliver long-term sustainable growth while having a positive impact on society,” he says.

Recent examples include its investment in Zenobe – a market leader in the UK for grid-scale batteries and electric buses. “As the use of renewables increases, companies like Zenobe can provide the support required to cope with sudden variances in supply,” Armanini says.

“Another is our investment last year in EnergyNest, a Norwegian thermal storage company which specialises in capturing and recycling surplus heat generated from industrial processes – or using it to generate renewable electricity,” he adds.

In its 2021 whitepaper Scaling up institutional investment for place-based impact, the Impact Investing Institute studied the risk profiles of various asset classes available to pension funds, with a particular focus on alternatives, such as private equity, infrastructure and hedge funds.

“Drawing on the Pensions and Investment Research Consultants’ annual review, we found that return for unit of risk is highest in these alternative assets, including property, providing a compelling financial case to invest in these asset strategies,” the Institute’s Gordon says.

Infrastructure interest

The reason institutional investors want exposure to infrastructure is usually threefold: the long-term investment associated with the asset class, ESG or social impact motivations, and the inflation-linked flows.

“The income streams from investments of this area increasingly important for a maturing scheme like ours and are a key part of meeting our primary objective,” says Graham of the South Yorkshire Pension Authority. “That they also support our broader goals in terms of sustainability. And they are more attractive than other investments that do not have the full combination of these characteristics.”

For Dowdall, there is a main reason why the Greater Manchester Pension Fund invests in the asset class. “All three can be achieved, but the primary aim always has to be the long-term inflation linked cashflows to pay our pension liabilities,” he says.

But for Sarah Gordon there are more than three attractions. “Investments in infrastructure have a powerful multiplier effect and can play a critical role in supporting local communities and the local economy – improvements to infrastructure can help to unlock an area’s potential and support improvements in a myriad of other areas, from the viability of new homes to access to education and work opportunities,” she says.

Stressing the investor benefits of infrastructure, Armanini says: “Infrastructure assets typically benefit from strong incumbent market positions, which can protect investors from wider market volatility and offer resilience during economic downturns. The essential nature of infrastructure assets can represent a reliable foundation for delivering returns that are uncorrelated with other traditional asset classes.”

Aligning objectives

Infrastructure is also a diversified asset class, ranging from clean energy through to transport and digital communications. “This range means institutional investors can select the opportunities which most align with their overriding objectives – whether this be predominantly climate-focused, social-focused or otherwise,” Gordon says.

Investment in real assets, like infrastructure, can also provide income streams as they are underpinned by revenue generating models, with returns often inflation-linked, providing a particularly good match for pension payments.

“Investing in local infrastructure is therefore a compelling example of our place-based impact investing approach – securing risk-adjusted financial returns while enhancing local resil- ience, advancing regional development and improving people’s lives,” Gordon says.

Fawcett also sees the advantages for Nest’s members. “We think illiquids present great opportunities for our members as a source of higher and more stable returns. Our members are investing for decades, in some cases up to 50 years, so we can put their money away for the long-term and help generate an illiquidity premium.”

In addition, Fawcett adds other attractive factors for investors. “Global unlisted infrastructure has shown itself to be a strong performer, fairly insulated from the performance of the global economy. We believe this will continue and be a useful diversifier of our portfolio, while reducing our reliance on other growth assets such as equities,” he says. “The direct relationship with the asset can also help us manage key ESG risks. In particular, we believe investing directly into green energy infrastructure will play an important role in helping us achieve our net-zero ambitions.”

Core of infrastructure

For Ted Frith there is an essence in the attractiveness of infrastructure. “Core infrastructure appeals to pension funds like our members because it offers long-term, stable cashflows and inflation-linked returns that align well with the liabilities of a pension fund,” Frith says.

“Social and ESG-linked projects in particular also appeal to the objectives of our members and those they represent,” he adds. “After all, as well as fulfilling their primary fiduciary role, pension funds also consider which investments are attractive for other reasons, and investors increasingly want to see money spent on reducing carbon emissions and tackling climate change.”

The focus on infrastructure investment has never been greater and, it represents a clear benefit to the broader economy, in terms of driving growth. “As well as playing a beneficial role in a portfolio, and helping to support the climate change agenda, infrastructure investment in general has a strong positive impact on economic growth,” Frith adds. “It is possible to see the tangible benefits as we refresh and evolve services and facilities for the benefit of local communities across the UK.”

Potential risk

Infrastructure is, therefore, a natural investment world for institutional investors, but it’s not without its pitfalls. “It is an exciting time, but as ever risky,” Dowdall says. “The long-term nature of these investments coupled with the natural illiquidity of the asset class mean that when paying the current prevailing market prices there is only a fine margin of error in asset specific due diligence given the potential risk of an inflexion point in long-term interest rates and inflation.”

Offering an insight into infrastructure equity investment for a pension fund, Fawcett has some words of warning. “The costs of investing in something like infra equity have typically been too high for defined contribution (DC) schemes. But Nest has been able to use its scale and long-term focus to negotiate good fee rates. We have also found workable solutions with our infra equity fund managers to overcome issues such as daily pricing.”

In turn, the issue over pricing needs to be addressed. “To help further open up the market to other DC schemes, there needs to be a better discussion about cost and value – as they are not the same thing,” Fawcett says. “We challenged the private credit market to review their fees and investment structures and think ahead to the opportunities available with the growth of defined contribution pensions. They stepped up to the plate and the infrastructure equity managers we are working with have followed suit.

“We are comfortable paying more for some asset classes over others because we recognise the trade off, but some fees charged remain prohibitive for many DC investors. More fund managers still need to sharpen their pencils.”

Delivering growth

The scenario of institutional investors focusing on infrastructure is vital going forward, Frith says. “Crowding private capital into infrastructure in the UK will be essential to support taxpayer funded initiatives if we are to deliver half of the government’s aspirations. We have been investing in core UK infrastructure on behalf of pension funds for more than six years, and are very excited to do more.”

Frith does note, however, that much has been achieved in a short period. “A great deal of investment has been made during the past two to three years and, with the progress of initiatives like the government’s UK Infrastructure Bank and recent Levelling Up whitepaper, we stand ready to explore further projects that can deliver stable, long-term inflation-linked returns for the benefit of our pension fund members,” Frith says.

Although Graham observes that while institutional investors are important in the infrastructure narrative, it cannot be built by them alone. “Institutional investment cannot be the panacea that addresses all infrastructure needs. We can be a part of the solution, but not all of it.”

Infrastructure investment represents an integral part of the government’s Levelling Up agenda, and it will be interesting to see how private capital can be invested to help rebuild key public services such as schools, roads and hospitals across the regions.

Ted Frith, chief operating officer at infrastructure investor GLIL

Box out: Infrastructure and Leveling Up

The government’s Levelling Up whitepaper offers many positives on the infrastructure front. “Infrastructure investment represents an integral part of the government’s Levelling Up agenda, and it will be interesting to see how private capital can be invested to help rebuild key public services such as schools, roads and hospitals across the regions,” says Ted Frith, chief operating officer at infrastructure investor GLIL.

In tandem with this, the UK Infrastructure Bank is attempting to identify the most pressing and viable projects in need of funding for local, regional and devolved administrations. “If it plays this role successfully, it could spark a surge in infrastructure investment that will help regenerate our economy and support the needs of local communities,” Frith says.

“For funds like GLIL, the UK Infrastructure Bank and Levelling up agenda present a significant development in the market, but what we ideally need is for our local and regional leaders to be clear about their investment priorities, so that we can assess the projects,” he adds. “The government is facilitating this, and the UK Infrastructure Bank is an important step.”

For Sarah Gordon, chief executive of the Impact Investing Institute, the publication of the Levelling Up whitepaper and the ambitious goals it laid out was a welcome step forward – particularly the announcement of a 5% local investment target by local government pension schemes.

“This new target will encourage pension schemes to consider the real opportunities presented by investing for impact in UK towns, cities and regions across all of the investment opportunity areas that make up our place- based impact investing model – from SME finance to infrastructure,” Gordon says.

The announcement, however, is only half of the story, Gordon says. “If the ambitious aims of the whitepaper are to be met, and pension funds fulfill their 5% target, local schemes will have to be supported by government along with other organisations to allocate to these types of investments.”

Box out: Nest: An insight into infrastructure investment

Workplace pension provider Nest has taken a threefold infrastructure approach. Last year the master trust appointed three infra equity partners – CBRE Caledon, GLIL and Octopus Renewables – to invest in projects in the UK and around the world, with a particular interest in renewable energy. “The types of infrastructure Nest could invest in include fibre networks, electric vehicle charging hubs, water and waste treatment plants and roads,” says Nest’ chief investment officer Mark Fawcett.

CBRE Caledon’s mandate is to help Nest invest directly in global core and core-plus infrastructure projects. “They provide access to an infrastructure fund sponsored by the firm, with the opportunity to also co-invest in select invest- ments to help Nest members take advantage of bigger projects,” Fawcett says.

“GLIL Infrastructure is a unique organisation, representing a joint venture between a number of major local authority pension plans,” Fawcett says. “Nest will invest in the fund along with GLIL’s members, with its open-ended fund giv- ing access to new opportunities in UK core infrastructure.”

Octopus Renewables is the largest investor of utility scale solar power in Europe, as well as a leading UK investor in onshore wind and biomass, managing a global portfolio valued at more than £3bn. “Nest has appointed the firm to boost its investment in clean energy infrastructure and has already deployed money into projects such as a solar farm based in Reading and biomass power plant in Brigg,” Fawcett says.

Box out: Infrastructure: Going green

Like the majority of investments, green projects are central to the growth of infrastructure. Greater Manchester Pension Fund’s Paddy Dowdall cites the importance of renewable energy. “There is a need for a vast amount of renewable energy, plus the networks to support that and maximise the effectiveness of such generation, including battery storage and electric car charging infrastructure, requires a huge amount of investment. New residential development requires a huge amount of energy supply,” he says.

“We have a well-diversified portfolio pipeline and are looking for new opportunities but one interesting example is a platform to invest in battery storage,” Dowdall adds. Infracapital’s Michele Armanini also places an important emphasis on a shift to the opportunities presented by greenfield sites. “While the operational brownfield infrastructure market is now maturing, greenfield infrastructure is still seen as a relatively new way of investing for pension funds,” he says.

“By providing access to infrastructure earlier in the asset cycle, greenfield investment can result in more attractive yields during the operational phase when compared with traditional brownfield investment.” Entering at the greenfield phase allows investors to come in ‘at cost,’ meaning long-term investors can typically enjoy a significant return premium over brownfield investments during an asset’s lifespan, including enhanced yields, Armanini says. “Greenfield infrastructure also appeals to investors because of its ability to bring clear benefits to the economy,” he adds.

While foregoing yield during construction, which can vary from several months to several years, greenfield projects essentially become brownfield assets once operational, carrying all the associated attractive characteristics – including secured, reliable cashflows linked to inflation, alongside the potential for capital growth.

“Greenfield infrastructure is not without risk, so asset managers must have a robust risk-monitoring, structuring and management process in place,” Armanini says. “Effective cost management, allowance for overruns in timetable and budget, as well as careful structuring of contracts, are all important risk management techniques.”


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