Natasha Browne asks why UK pension funds tend to lose out to international rivals on big infrastructure investments
A 25% stake in London's King's Cross development is an attractive investment for UK pension funds. The 67-acre site includes offices, hotels, a university, shops and restaurants. Tellingly, however, it was the $84bn (£44bn) AustralianSuper that won the mandate in February.
It follows the announcement that Canadian pension fund manager Caisse de dépôt et placement du Québec (CPDQ) and Hermes Infrastructure bought the government's 40% shareholding in Eurostar for £585.1m. They faced competition from the £42bn Universities Superannuation Scheme (USS) and the £5bn Lancashire County Pension Fund (LCPF).
LCPF's chief investment officer Mike Jensen believes the fund was a close second to winning the bid. He says: "Part of the problem from our perspective was that this was relatively new ground for us. We hadn't already established strategic partnerships with any other investors so we were the sole bid for that particular asset."
He adds: "That probably made us slightly less price aggressive than maybe we would have been if we'd been in consortium." LCPF is now in the process of partnering with the London Pensions Fund Authority (LPFA), which would approximately double the assets under management in a joint venture. Jensen says Lancashire has a reasonable appetite for large infrastructure deals.
Still, a significant barrier for UK schemes trying to access these projects is scale. A £5bn scheme will struggle to win a bid against a fund almost ten times its size. Another issue is allocation. Hermes infrastructure partner Hamish de Run says UK schemes allocate around 2%-3% of their total fund to infrastructure. This compares with 7%-10% for Canadian or Australian funds.
"Not only do we have smaller funds here in the UK and a much more diverse universe of funds, overall allocation to infrastructure is lower. Once you start multiplying that out, you become very small very quickly," de Run says.
According to Jensen, schemes need to build up their in-house resources if they are going to either contend with or cooperate with international rivals. He says: "There is a strategic question over whether you are prepared to pay for top-quality internal resource that will almost certainly ensure you pay less overall in turn of external fund manager fees."
Head of M&G's infrastructure investment arm Infracapital Martin Lennon notes that UK schemes have traditionally only accessed infrastructure indirectly. He says: "Their reliance on working with or through other fund managers or partners may be because they do not have the in-house expertise to access the asset class directly. And that's made it a lot more difficult in situations where a lot of infrastructure investments and businesses can be very large in size."
Experts predict pension fund investing in infrastructure will grow, albeit as much through defined contribution (DC) as defined benefit (DB). De Run says: "We think the DC area is going to be much more of a focus, which is really what the Canadians and Australians have. They're just continually growing."
Lennon adds: "DB still has a role to play but obviously with the rise of DC I think people like us are giving quite a lot of thought to how we can tailor access channels, products etc, to ensure all of the infrastructure asset class still works in a DC context."
Schemes investing in the asset class a decade ago were met with a lot of risky funds, de Run explains. They were poorly differentiated and highly leveraged. In 2012, 22 schemes unsuccessfully tried to sue an asset manager for allegedly breaching its mandate after an infrastructure fund lost two-thirds of its value. But over the last four years, investors and managers are focusing on core infrastructure projects, which deliver more long-term stable returns.
De Run says: "The UK pension fund market is recognising that there are managers and access points out there that aren't as risky as they might have seen in the past. Previously it was a very private equity-style vehicle and you were asking ‘well is it private equity or infrastructure?' That market now is much more clearly defined."
Different funds also had varying experiences with external managers, USS head of real assets Gavin Merchant says. While some managers did a good job in acquiring the right sort of infrastructure assets at the right price, other funds experienced investments in some combination of the wrong assets, the wrong price and inappropriate capital structures, he says.
Merchant adds: "If your experience was of the latter kind, then greater control over the investment decisions is of much greater importance in driving the decision to go direct."
While Jensen agrees that manager fees can be expensive, he echoes de Run when he says the real issue in the past was that most infrastructure investments were private equity vehicles. That meant they had a seven to ten-year time horizon, which was too brief.
"We were ending up with relatively short-term investments that didn't chime with our underlying thesis for infrastructure, which is long-term cash flow, RPI-linked investments that we could maintain an interest in for 20-25 years," Jensen says.
In an effort to skill up, Lancashire has recruited experienced market professionals and is looking to hire more in the future. It is also hoping to meet with government ministers in the next few weeks to get greater direction on how it plans to run sales and privatisations going forward.
- The AustralianSuper made its second direct UK investment in February, taking a 25% stake in London’s King’s Cross
- One of Australia’s largest superannuation funds, it partnered with Hermes for the second time to secure the deal, and will join the King’s Cross Central Partnership
- The partnership includes Argent King’s Cross Limited Partnership, which is backed by Hermes, as well as Argent, DHL Supply Chain and London & Continental Railways
- The site includes eight million sq ft of offices, homes, hotels, leisure, shops, restaurants, a university, galleries, schools, community facilities and music venues
- AustralianSuper, which represents over two million members, was advised by its UK-appointed mandate manager, TIAA Henderson Real Estate
- The fund previously purchased half of the Centre MK shopping centre in Milton Keynes from Hermes in December 2013
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