Infrastructure investment – what do you need to know?
13 Jun 2019
Infrastructure can be a positive addition to many pension funds’ investment strategies. However, until recently, relatively few UK schemes have invested in it and even fewer in any scale, with many put off by the complexity of the asset class and difficulties in accessing suitable investments efficiently.
In recent years the Government has been supportive of pension schemes, both in the public and private sectors, investing in infrastructure. At the same time, the asset class is becoming increasingly accessible and schemes are recognising the benefits of infrastructure.
The Ministry of Housing, Communities and Local Government (MHCLG), in their recent draft guidance to LGPS pension funds, included a strong steer to consider investing in infrastructure projects. It suggested LGPS funds should be moving towards infrastructure investment at similar levels to overseas pension funds of comparable size.
So how much do overseas schemes actually invest in infrastructure? The answer varies quite a lot. While Australian and Canadian schemes often have sizeable allocations to infrastructure (5% - 15% is not unusual) many large European pension schemes still have little or no infrastructure assets, i.e. UK infrastructure allocations are not out of line with the majority of global investors.
Given some others have made significant allocations, are UK funds missing out and are there wider benefits to be gained by using fund assets for projects which also help develop and improve local areas?
The increasing industry focus on responsible investment has led many to consider not only the financial return that can be generated from investments, but also the impact that investment can have. And the two objectives are not incompatible. Infrastructure allocations can meet funds’ responsible investment aims in a variety of ways, for example, investments in renewable energy projects or affordable housing offer the chance to provide a social or environmental benefit, as well as a return profile which helps to pay fund liabilities.
Infrastructure projects vary greatly, and there are a range of ways funds can invest. One key distinction is between “greenfield” and “brownfield” investments. Greenfield investments are new projects, involving the design and construction of the assets as well as the ongoing management once it has been built. This can incur additional risks at the outset, as design or construction problems can lead to cost overruns or delays which can impact on the overall returns (although many infrastructure investments are structured to reduce these risks as far as possible). However, investing in greenfield infrastructure projects also creates the impact that many want to see.
Brownfield investments are those which are already established, but which need to be managed and potentially renovated or improved. And to clarify a frequent point of confusion, the green/brown titles don’t have any relationship to how environmentally friendly the investment is!
Although infrastructure investments may still be more complex than more traditional investments, the asset class offers some interesting investment opportunities and good long-term return potential, as well as the potential to use fund assets to have a wider impact. The move towards LGPS pooling should also help remove some of the historic barriers cited by UK investors, potentially allowing allocations to increase towards those seen in Australia and Canada.