Andrew Short looks at how pension funds can get involved in infrastructure investment
Infrastructure projects have been on the coalition's political agenda since David Cameron announced plans to unlock £200bn of capital from investors as part of the UK's first National Infrastructure Plan, in October 2010.
As part of this plan a Treasury spokesperson said: "We are in early discussions with UK pension funds to identify what can be done to encourage them to invest in UK infrastructure."
Speaking at the London School of Economics on 13 September, Nick Clegg once again highlighted the importance of infrastructure for driving growth in the faltering UK economy - just in time for the updated and more detailed version of the National Infrastructure Plan expected in November.
Mr Clegg commented that "infrastructure does not come cheap" and that the "absolute crux" is to stimulate private investment in this area. As some of the largest investors in the country, pension funds have been encouraged to allocate cash for investments in these projects. There is now talk of pension funds being the saviours of the UK economy - keeping the lights on and stimulating growth through an infrastructure investing revolution.
This idea may be a little far fetched when you consider that compared to, say, Canada or Australia, investment by pension funds into this asset class are relatively small, but there is a buzz surrounding the idea of infrastructure investing at present.
Many consultants and trustees are being lured into (or certainly considering) infrastructure with the promise of long-term and, potentially, inflation-linked returns.
However, according to Redington co-founder and co-chief executive Robert Gardner the way investments are structured can produce differences in their characteristics. Funds could be holding the asset class but the way it is accessed could make all the difference. "The key is being able to get involved in these projects on an unleveraged basis," he adds.
Equity versus debt
There are a number of ways pension schemes can get involved with infrastructure investing. Traditionally, pension funds bought and sold shares of listed infrastructure companies. The fund could, for instance, own shares in a water utility in the UK. This approach requires expertise and resources - many smaller schemes would not be sophisticated enough to do this.
Another way to invest in infrastructure is to gain exposure to the asset class through a fund. In the UK, the Merseyside Pension scheme is the most recent example of this. The scheme has sunk £20m into AMP Capital's Strategic Infrastructure Trust of Europe - (PP Online, 22 Aug, 2011). Investing through this route often requires due-diligence on behalf of the scheme because of the different regulation, governance, and reporting requirements of assets the fund may hold.
The structure of some infrastructure investments makes them look more like a private equity venture also. In the UK this has been under the PFI or PPP banner. Redington's Gardner explains this is an important factor to consider when looking at the asset class: "Typically, a thin layer of equity was provided by a pension fund, say 10% of the overall project and the rest financed through debt. So this gave you a 10% equity/90% debt structure."
For those invested in the equity slice of the structure this can be problematic. These investments have been sold on their long dated, secure and stable nature. Except they are highly leveraged, and also some assets may be highly cyclical. Take the example of an airport - during a recession less people may travel so the profit of the asset is lessened.
If this happens cashflows are now only being used to service the debt holders: Gardner adds that bond holders have been tapping into these assets and getting high quality, investment grade returns. "For the equity investors," he adds, "the leveraged format means a safe asset is being converted into a more private equity style asset."
The National Association of Pension Funds senior policy adviser David McCourt believes there needs to be a clear separation of the equity/debt issue to understand infrastructure. "You can issue equity, but it must be remembered it is going to have the characteristics of equity - there needs to be a weighing up of the risk/return profile."
McCourt and others mention there has been a greater interest in the debt side of infrastructure investments. There is not a sufficient supply of index-linked bonds, so pension schemes are looking for other ways to replicate these types of returns with infrastructure debt. But where is all this debt hiding?
This week's top stories included Cardano announcing plans to acquire Now Pensions from a Dutch pension fund later this year.
Royal Bank of Scotland (RBS) faces a £102m impact on liabilities as a result of equalising guaranteed minimum pensions (GMPs), according to its annual results.
Malcolm Mclean says getting the channels of communication right and engaging more openly is a good starting point