Infrastructure investment is beneficial for the development of society and helps to improve people’s quality of life, but it can also help generate stable, inflation-linked investment returns for defined contribution (DC) pension funds.
Despite this, relatively few pension funds have included allocations in their default fund arrangements and even those that do only have modest allocations. Policymakers, government ministers and regulators have all been encouraging pension funds to invest in patient capital such as UK infrastructure.
AgeWage CEO Henry Tapper says there are three main forces driving the move towards infrastructure investment. “First, there is a political need to build back better after Covid- 19, second, real assets can help deliver better outcomes for pension fund members, and third, there is a huge move towards investing sustainably.”
Illiquidity and costs are just some of the challenges for schemes when it comes to investing in this niche asset class – but the Department for Work and Pensions (DWP) has been trying to reduce some of the hurdles.
Accessing infrastructure
Infrastructure is accessible through equity and debt, and there are a range of passive and actively managed pooled funds available.
But Jayna Bullar, investment consultant at Quantum Advisory, says these can be quite expensive and subject to minimum investment criteria, which is challenging when DC default funds are required by aw to keep their costs within 75 basis points.
“The use of a third-party experts, in the form of active investment managers, can provide additional reassurance around the management of assets and projects that capital is directed towards,” she says.
Investing in the equity of infrastructure companies provides a liquid and cost-effective way to access the asset class while debt is typically less liquid and has less transparency, Bullar adds.
“While infrastructure assets tend to be less sensitive to economic weakness in the short- term, equity will naturally be more volatile. Therefore, its use within the default fund should consider the risk profile of the broader membership and time until retirement.”
She argues a blend of equity, debt and direct holdings would be “optimal” to help manage both liquidity and cost. However, this would reduce some of the diversification benefits that pure infrastructure investments provide. “Even with such an approach, costs may still be substantively higher than traditional asset classes and may require the remainder of the default fund to be invested passively,” she says.
Multi-asset funds can provide exposure to a range of alternative assets, which can include infrastructure debt and equity.
Unlisted infrastructure
One pension fund that has been exploring private infrastructure investments is the National Employment Savings Trust (Nest) which has about £15bn total assets under management. Its head of private markets Stephen O’Neill says direct or unlisted infrastructure investments should no longer be out of reach for larger DC schemes – although he admits they can be hard to access.
“Larger schemes can overcome challenges around costs and illiquidity because they can find fund managers who are willing to be innovative on fund structure and have the scale to negotiate hard on fees,” he says.
For example, Nest has been looking into private infrastructure equity for quite some time, and has carefully considered fees and investment structure when analysing how this asset class can bring value to its investment portfolio and its members’ pots.
The scheme revealed in January it would seek to increase its total private assets allocation from 9 to
15 per cent of its overall investments, and has been searching for asset managers for its new allocation to unlisted infrastructure equity.
“Pension schemes are going to have to work harder in future to help deliver the returns members want and need, and we think unlisted infrastructure will benefit members’ pots in the long term,” says O’Neill.
He explains that unlisted infrastructure offers a return profile that “correlates strongly over the long term with either or both inflation and GDP growth”, a correlation which applies to both overseas and UK infrastructure
Having tangible assets that members can recognise is an “added bonus” from a member engagement perspective, says O’Neill. “We believe telling members about these types of investments will help us bring them closer to their money and to understanding what happens to it when it’s invested in a pension,” he explains.
Australian model
FM Investors, an infrastructure manager which is owned by 27 not-for-profit Australian DC pension funds, believes long-term unlisted infrastructure in open- ended funds is appropriate for DC pensions because members are on average younger, the schemes are open, and capital growth is sought. Gregg McClymont, who is executive director for public affairs at IFM and also a former UK shadow pensions minister, says the Australian model’ is based on this structure and has helped the country’s industry DC funds to increase large infrastructure allocations to around 10 per cent on average.
“As UK DC scales, this approach becomes more attractive as the cost and governance demands of the ‘Australian model’ are more easily met by a net benefit approach to value for money becoming the norm, and also as DC chief investment officer offices grow in size and scope,” he adds. But can UK pension savers benefit from their money being invested in UK infrastructure even if the returns from the asset class may not be end up being as high as they could have been?
Quantum’s Bullar says: “Naturally, for DC default funds, a balance needs to be struck between driving the social benefit and giving members the best chance of having sufficient capital to fund their retirement. Incorporating infrastructure into the wider investment strategy of a default fund, can achieve this.”
Also, the benefits of infrastructure are providing diversified and long-term stable returns rather than the highest possible returns.
Pension funds should invest in line with their fiduciary duty to members, McClymont acknowledges.
He adds: “As DC scales, there will be more opportunities to invest in greenfield infrastructure both in the UK and abroad, but this depends on governments developing the right models.
“IFM’s ‘Build Britain’ approach seeks to match pension capital with its appetite for long-term stable returns to large scale infrastructure projects which the UK government seeks to get off the ground.”
Tapper is optimistic given that all decision-makers are driven to increase infrastructure investment in the UK.
“Everyone from Chancellor Rishi Sunak and Guy Opperman in DWP, to Boris Johnson in Number 10 are saying there is an imperative that we get our pension schemes working for the country, working for the social good and towards net-zero carbon emissions,” he says.
Creating the right opportunities for pension funds while relaxing DC regulations could encourage the adoption of infrastructure investments, while helping to accelerate the post-Covid-19 recovery and drive the green economy.
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