Infrastructure – Feature
“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 infrastruc- ture equity investments can offer diversification benefits and a return premium to public market equities, at lower levels of risk.”
Insurer advantage
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 estab- lished: where pension liabilities are sold to an insurance com- pany, 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.”
Smaller benefits
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’ bene- fits with an insurer through a PRT transaction, smaller pen- sion 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 commit- ments 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 improvement
Typical fund structures have tended to be less accessible
to smaller schemes. Gavin Smith, Legal & General Retirement Institutional
Infrastructure is also an area primed for investor improve- ment. 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 offer 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 min- imisation 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 mad- ness of crowds,” he adds.
Issue 103 | May 2021 | portfolio institutional | 53
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