Andrew Short looks at how pension funds can get involved in infrastructure investment
Debt monopoly
Before the credit crunch, infrastructure debt was the preserve of banks. This is changing because of impending regulation. The illiquid nature of the asset class has meant that large commercial banks cannot have this cash locked up on balance sheets.
This has created a huge funding gap. Senior infrastructure debt funds are now making an appearance onto the market; the first fund of its kind was set up by Barclays Capital - (PP Online, 28 July, 2011)
This fund has been set up to link pension schemes to high-quality UK infrastructure debt. Barclays Corporate head of infrastructure debt David Cooper said: "Other infrastructure funds that are based in the UK invest in the equity of these projects so they are very much at the riskier end of the capital structure." He adds that the attraction of the fund is that institutional investors can invest in the other 90% of the capitals structure in the form of long-term debt, this investment has a risk/reward profile that pension schemes are seeking.
The fund is also seeded with £200m of assets that have already gone through the construction phase. This is to mitigate construction risk for investors and start the flow of margin payments. Cooper also believes that these types of funds will become more popular and will coax institutional investors into the infrastructure debt market. As the assets in the fund are also based in the UK it will also go some way to help fund the National Infrastructure Plan.
The final way
The most sophisticated way to invest in infrastructure is to go 100% direct and own the full capital structure. This kind of investing is only really open to the largest schemes and has gained traction outside of the UK. The most high profile example is the acquisition of the High Speed rail project by Canada's two largest pension schemes - The Ontario Teacher's Pension Plan and The Ontario Municipal Employees' Retirement System.
There are also more practical issues that may be holding up this type of investment, the first is bidding for the asset, which according to Towers Watson consultant Duncan Hale is a difficult process, and the due-diligence is another factor. "When you consider there are a number of managers out there with more that 20 people looking at these assets, it's not a small task for a pension scheme."
The next issue he identifies is managing these assets over time; this is because they are still businesses and require a certain amount of skill to run. For this kind of investing to catch on in the UK there will need to be more clarity on how infrastructure projects will be offered up and if the government will underwrite certain parts. Mercer's lead infrastructure researcher, Amarik Ubhi feels "a key issue for pension schemes is that there needs to be political and regulatory certainty in order for them to continue to invest into the asset class."
Swimming in cash?
There is one flaw in the National Infrastructure Plan: the governments may not get the volume of investment required because pension schemes may not have the available cash. The NAPF's McCourt believes it is important to avoid the idea that pension schemes are swimming in cash. "They don't tend to keep reserves in huge amounts," he adds, "There will need to be some re-allocation."
Again the big question is how this investment will be offered and this will have an impact on how pension schemes will allocate it. The highly leveraged nature of many infrastructure projects, according to Towers Watson's Hale, means that it is hard to look at it as a bond substitute.
"While cashflows have a degree of stability, they are not liability matching assets, because there is risk in these assets. If more senior debt funds are set up and smaller schemes can access more secure, long-dated debt then pension schemes that are trying to de-risk and plug deficits may re-allocate more of their portfolios to this debt.
The final question to ask is if pension schemes in the UK have a wider role to play in the economy. Some schemes may are aware of economic and social issues and others may only fulfil their fiduciary duty. Gardner feels this issue falls into a hierarchy of needs. "The social aspect is a positive but not the raison d'être the raison d'être is to access long-dated inflation-linked cash flows where you are tapping an illiquidity premium - the fact that infrastructure investing is meeting a social aspect is the cherry on the cake."
