Infrastructure is attractive to long-term investors needing regular cashflows. The future looks bright. Andrew Holt reports.
For institutional investors, infrastructure is a portfolio diversifier with benefits. The good news is that the outlook for the asset class teases plenty of opportunity for investors to collect secure, regular cash returns. The government faces a steep upgrade and modernisation bill, which could be good news for long-term investors, such as pension schemes.
“Infrastructure is seen as a diversifier – you can define that mathematically in terms of correlation co-efficiency – but you can also look at it in a more simplistic way, in that you can achieve returns which are equity like, with some of the characteristics of the debt market and with typically lower volatility,” says Ted Frith, chief operating officer at GLIL Infrastructure.
But Stephen O’Neill, Nest’s head of private markets, warns that you have to select the right assets. “It’s clear that when chosen and managed carefully, unlisted infrastructure equity assets can offer stable, long-term returns even in difficult market conditions. These also provide a diversifier for growth away from equities.”
This attractive mix has understandable appeal to investors. “This has brought in many of the larger investors over the last few years,” Frith says. “Also, if you are a pension fund, you are making a real contribution to the facilities your pensioners might want to use, such as new trains or schools or hospitals and a contribution to the wider economy,” he adds.
Nick Silver, co-founder of the Climate Bonds Initiative, adds: “Pensions should be investing in infrastructure because this is a ‘real’ asset. Infrastructure is also a good match for pension fund liabilities as it generally provides a steady inflation-linked return.”
This role in boosting UK plc can be seen as a big contributing factor for investors. It is also an area where a great deal of innovation is happening, with investors having the chance to share in and exploit many of the infrastructure initiatives taking place. For example, for Britain to meet its climate goals, accounting firm PwC estimates that infrastructure spending would have to double to £40bn a year.
And pension funds have a massive role to play in boosting and benefiting from this outlay. The unlikely advocate in this scenario is the government, which in its National Infrastructure Strategy sets out the enthralling prospects for pension schemes. “There is a huge opportunity for pension funds to support the UK’s infrastructure investment ambitions,” notes the strategy.
It puts real numbers on these opportunities. “The industry anticipates that pension funds and insurers will be able to invest between £150bn and £190bn in infrastructure over the next 10 years.”
That is a big investment opportunity. There is also a good harmonisation benefit for long-term investors, such as pension funds which are well matched to the long-standing nature of infrastructure investment. “We look for projects that essentially, align well with pension fund liabilities – very long-term opportunities, 25-years plus,” Frith says, “and tailored to what the pension fund wants in terms of capital, deployment, risk and cash flow.”
Nest is focusing its infrastructure equity mandates on core operating assets globally, with some room for core-plus assets as well as some green field renewables projects. “We have divided our infrastructure equity mandates into three: core/core plus global; European renewables; and UK core. We also allocate to global infrastructure debt,” O’Neill says.
The opportunities highlighted by the National Infrastructure Strategy are already apparent to O’Neill. “We see some great deals in the UK in our managers’ pipelines, in the north of Europe and the UK in particular, which provide strong origination opportunities in onshore wind and other renewables,” he says.
“We also like that we will be allocating a meaningful amount of our portfolio to UK assets with a strong linkage to inflation in their return profile – as this helps support our long-term investment objectives which are earning a spread over the UK Consumers Price Index. With that said, we are a global investor and we want to avail of opportunities from developed countries around the world.”
Banking on infrastructure
As part of this, possibly the most far-reaching development is the arrival of the National Infrastructure Bank, announced in November by the chancellor of the exchequer, Rishi Sunak. According to the National Infrastructure Strategy, the new bank has a big, far-reaching remit. It will “co-invest alongside private-sector investors including banks, institutional investors, sovereign wealth funds, pension funds and global infra- structure investors.”
It will also use “a range of tools to support private projects: as well as offering guarantees through the existing UK Guarantees scheme, it will offer debt, equity and hybrid products.” Commenting on this, Frith says: “What I hope is that the National Infrastructure Bank does two things: one is that it can play a co-ordinating and strategic role and secondly, I hope it can generate more supply of projects to provide more opportunities for investors. I am encouraged by what I have heard. The proof will be what happens in the next couple of years.”
But while a supporter of the National Infrastructure Bank, Silver is sceptical about its funding. “Its balance sheet is £22bn compared to £2.2trn [market size], which isn’t going to make much of a difference,” he says.
In another measure, the government announced in the budget it would like defined contribution (DC) schemes to invest in more alternative assets – widely seen as a hint that they should be free to invest in infrastructure.
“There is a lot going on at the moment to make this work,” O’Neill says. “The DWP are consulting on performance fees within the charge cap while the government has set up a task force to look at how a ‘long-term asset fund’ can be created to meet these ends – we believe this is an important push to help DC schemes overcome the hurdles, operational and commercial, which have effectively prevented them from allocating to infrastructure in the past.”
Although investing in infrastructure can come with a big price ticket, which can put the asset class beyond the reach of many funds, there are examples of schemes coming together to pool their assets. In November, a group of local government pension schemes announced they would be pooling £840m to invest in infrastructure projects through the Brunel Pension Partnership.
“You get the benefit from buying in scale: the capital scale, which drive down fees and other costs but also the benefit of being able to potentially bring things in-house,” Frith says. “And you can often get a better outcome for your pension fund by building a portfolio with the pension fund or funds in mind.”
And the range of portfolio initiatives are ever expanding. Infrastructure, which is to make up 5% of Nest’s portfolio by the end of the decade, has seen the auto enrollment pension scheme establish a new partnership with a private infrastructure investor and GLIL Infrastructure to invest £3bn directly in global core and core-plus projects. The types of infrastructure Nest will be investing in include fibre networks, social housing, water and waste treatment plants and seaports.
“Nest’s investment strategy is evolving at pace in line with the growth in our assets under management, opening up new assets classes in the pursuit of the best risk-adjusted returns for our members,” O’Neill says. “We believe direct infrastructure equity investments can offer diversification benefits and a return premium to public market equities, at lower levels of risk.”
In addition to the wide range of infrastructure opportunities, Legal & General’s The Power of Pensions report indicates how small pension schemes can get involved by looking to manage their liabilities through the pension risk transfer (PRT) market by offloading pension payments to an insurer.
The insurance market’s involvement in pensions is well established: where pension liabilities are sold to an insurance company, and they in turn pay the pensions, essentially contracting out the pension fund, for a fee.
In reference to the development of PRT, Gavin Smith, head of pricing and execution, pension risk transfer at Legal & General Retirement Institutional, says: “While these [small] schemes may want to invest in infrastructure and ESG-related holdings, the need for diversification and the illiquid, long-term nature of some of these investments can make it harder to incorporate them into their portfolios in a cost-effective way. In addition, typical fund structures have tended to be less accessible to smaller schemes.”
Looking at this in more detail, there are around £1.6trn of defined benefit (DB) pension assets on UK company balance sheets. Most British DB schemes are closed to new members and a large number are small – relatively speaking – with the Pension Protection Fund’s Purple Book 2020 showing that 72% of schemes have less than £100m of assets.
Smith adds: “Over recent years, we have seen developments on the investment and insurance side to open up this asset class to a wider set of smaller schemes depending on their circumstances. As funding levels improve, by securing their members’ benefits with an insurer through a PRT transaction, smaller pension schemes are also able to benefit from the fact that the insurer will be invested across a wide pool of infrastructure projects, including those with ESG credentials, which will allow them to offer a lower premium to the scheme.”
For example, a scheme transacting a pension buy-in or buyout may pass on part or all of its assets to an insurer in return for the security of the insurer meeting those pension commitments for the rest of the insured populations lives.
“We can then invest this pension money, in projects that have a real impact around the UK, including affordable homes, roads, new technology and renewable energy,” Smith says. “In fact, to date more than £24bn of our UK annuity portfolio is invested in direct investments that deliver a social, economic or environmental application,” he says.
Infrastructure is also an area primed for investor improvement. According to the Pensions Policy Institute’s (PPI) DC Future Book, currently around 1% of master trust default funds – where most scheme members reside – are invested in infrastructure. Putting this into perspective, Tim Pike, head of modeling at the PPI, says: “Investment in illiquid assets generally comes with higher investment costs.”
Therefore, larger, cash-positive schemes, such as master trusts, are more likely to be in a position to lock away a proportion of funds in anticipation of a potentially increased future return. “In this environment, costs are driven to a minimum to be able to o er a competitive charging structure and investment related expenses are typically around 15 basis points or lower,” he adds. “For such schemes to invest further in asset classes such as infrastructure, investment approaches need to consider returns and volatility measured net of charges – above the minimisation of headline charges – and for this to be recognised by those selecting schemes for their workplaces.”
But for Frith, the infrastructure outlook is positive. “There is a lot of investor appetite at the moment,” he says, although he offers a caveat. “And like anything, all investors should be guided by wise advice on what is suitable for their scheme. Don’t just follow the herd and get dragged along by the madness of crowds,” he adds.