Cover story
The UK is the first major economy to com- mit to a zero carbon emission target by 2050, which requires a fundamental change in the way the country produces energy. A laudable, but ambitious project for a cash-strapped nation; after more than a decade of austerity, local authorities strug- gle to fill their potholes, let alone invest in wind farms.
The funding gap is significant; some £483bn is needed, according to the UK gov- ernments’ National Infrastructure Delivery Plan 2016-2021. And with the government unlikely to increase its spending plans, it has set its hopes on private capital, and in particular pension funds, to meet the shortfall. But the uptake remains slow. Since 2006, UK-unlisted infrastructure funds attracted £50.8bn, according to Prequin, a fraction of the £4.8trn in investable assets held by UK institutional investors. At the same time, almost half of all institutional investment in infrastructure is in renewable energy, highlighting that inves- tors can potentially play a cru- cial role in the UK’s energy transition. But the average infrastructure allocation among defined benefit (DB) schemes hovers just under the 4% mark while defined contribution (DC) scheme investment in infrastructure is virtually non-existent. What is holding investors back?
DB – IN IT FOR THE LONG RUN? DB pension schemes have traditionally been the focus for policy-makers looking to attract infrastructure investment and it is easy to see why. Besides sitting on a signifi- cant pool of assets, their cash-flow require- ments align neatly with the returns offered by investing in sectors such as energy gen- eration, transport and social housing, which promise stable cash-flows and returns uncorrelated to equities and bonds. More than 60% of DB schemes in the UK are closed to future accrual. Almost half of all such schemes aim to achieve their finan- cial targets over a five-to-10-year horizon.
Only a small minority, 5%, are planning for more than 20 years, according to Aon’s recent Global Pensions Risk Survey. Conse- quently, there is now growing focus on managing cash-flows, infrastructure invest- ments are set to play an increasingly impor- tant role in that. Over the past year, DB schemes in the UK have significantly cut their equity exposure and simultaneously doubled their invest- ments in cash-flow matching assets to 20% as of July 2019. Infrastructure accounted for around a third of schemes cash-flow driven investing (CDI) allocations, a 10% year-on-year increase, according to a poll conducted by Fintech provider RiskFirst. More than half continue to access the asset class through funds, while only 19% chose to invest directly, according to Prequin, an
The launch of GLIL in 2015 could have influenced the thinking behind the govern- ment’s initiative to pool LGPS assets, which was announced in the same year. But four years on, it is still work in progress. In most cases, infrastructure remains the asset class which has not been pooled yet. The ACCESS pool, for example, is less than 2% invested in infrastructure. London CIV and Border to Coast are due to announce their first infrastructure investments later this year, but there has not yet been a signif- icant uptake in investment in this area. Meanwhile, accessing infrastructure as an individual scheme has its challenges. Cen- trica’s £8.5bn DB scheme has a strong focus on liability and cash-flow matching. Infrastructure is seen as one important ele- ment of CDI, rather than a separate
A lot of infrastructure funds essentially buy
something, improve it and sell it, but we wanted to get hold of these assets for the long term. Jonathan Ord, GLIL
alternative asset data provider. But invest- ing through third-party funds has its chal- lenges, says Jonathan Ord, investment director at GLIL. The £1.4bn open-ended infrastructure fund, initially backed by Lan- cashire County Pension Fund, Merseyside Pension Fund and West Yorkshire Pension Fund, was set up in 2015, prior to the gov- ernment’s local government pension scheme (LGPS) pooling initiative. “One of the frustrations that we encountered when investing in infrastructure was the short- term nature of some of the funds that were out there. As a pension fund we are very much long-term investors,” he adds. “By launching GLIL we were able to design a fund and a way of investing in infrastruc- ture that suited us. A lot of infrastructure funds essentially buy something, improve it and sell it, but we wanted to get hold of these assets for the long term. We focus on the core, low-risk part of the market, rather than the value segment,” Ord said.
28 | portfolio institutional | November 2019 | issue 88
category in the scheme’s portfolio, says chief investment officer Chetan Ghosh. “Infrastructure is one of the assets we are sourcing to get that long-dated cash-flow. We are interested in infrastructure assets where we hold the whole asset, things like renewables, biomass, solar and wind have been a big part of our CDI strategy. We see the risk-return and cash-flow generating profiles of these assets as suitable for our goal of having long-term cash-flows to meet pension payments,” he stresses. At the same time, Ghosh highlights two key challenges to increasing the scheme’s infrastructure exposure: finding assets in the right format and managing their liquid- ity. As a scheme with a relatively long investment horizon, Centrica invests in assets directly rather than owning them through a private equity structure. Then it comes down to sourcing suitable assets. Bigger is not always better, warns Ghosh. In many cases, there is a risk of overcrowd-
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