Data Crunch: Rush of pension capital into infrastructure continues

Alternatives now play a much larger strategic role in the portfolios of UK pensions schemes, with 40 per cent of new, planned or increased allocations focusing on these assets over the year, according to the business intelligence site.

Like many alternatives, the growing interest in infrastructure has been driven by an appetite for diversification and the illiquidity premium that exists over public markets. Accessible via debt or equity instruments, experts say stable demand secures the cash flows generated by core infrastructure projects.

Around £4.5bn of new mandates, reweightings to, and planned allocations to infrastructure were observed by the over 2018, significantly more than any other alternative asset class. Property was the next most popular asset class with inflows of around £2bn.

Asset managers and consultants are seeing the same interest on the ground from schemes.

On the equity side there has been a broadening of the number of funds that provide a straightforward exposure to infrastructure without the level of leverage that was previously involved

Simeon Willis, XPS Pensions

“They key driver of the appetite for infrastructure is just the ability for it to generate cash,” says Duncan Hale, portfolio manager of Willis Towers Watson’s Secure Income fund. In public markets, he says, “returns have really reduced, so finding an alternative to that is important”.

Mr Hale says the reliability of infrastructure income is driven by a “robust supply and demand dynamic” for core projects. Demand for water utilities, for example, is unlikely to be shaken by the political uncertainties affecting other markets, and a monopolistic supply further guarantees income.

Schemes flood into infra

It is for these reasons that a host of DB schemes allocated to infrastructure projects over 2018. The £220.4m Baptist Pension Scheme, for example, shifted 9.7 per cent of its assets out of a struggling diversified growth fund and into global infrastructure.

Meanwhile back in January 2018, the Northern Ireland Local Government Officers’ Superannuation Committee completed its entry into an infrastructure investment with Dutch manager DIF, joining notable schemes including the Church of England Pensions Board and the Lothian Pension Fund.

Investors appear to be satisfied with the performance of their allocations - a 2019 global infrastructure report by Preqin finds that 84 per cent of surveyed investors feel that the asset class met or exceeded their expectations.

Source: Mandatewire

Value-added, core, and core-plus were the strategies that global investors viewed as offering the best opportunities.

One important development in enabling institutional access to the asset class has been a reduction in fees and in risk.

“On the equity side there has been a broadening of the number of funds that provide a straightforward exposure to infrastructure without the level of leverage that was previously involved,” says Simeon Willis, chief investment officer at XPS Pensions. “The returns are more modest but have all the desirable features that a pension scheme seeks.”

Certain categories of infrastructure may become crowded, with excess demand driving down the return investors can achieve for a given level of risk. But Mr Willis says that if schemes pick experienced managers and give them sufficient scope to find opportunities, changing regulations should enable them to find “pockets of opportunity such as renewable energy.

Returns are not guaranteed

Infrastructure has come to be a wide-ranging asset class, but the stretching of its definition is a source of irritation for investors such as Mr Hale.

Investments in infrastructure projects that lack a monopolistic control of supply is “where we’ve seen infrastructure get in trouble in the past”, he says, explaining that while these assets have performed well in recent years, investors could come unstuck “when the tide goes out”.

Other risks are becoming apparent with infrastructure. At June 2018 there was a record $179bn of dry powder sitting in infra funds. Fifty-four per cent of managers responding to the Preqin survey felt that valuations would be a challenge for return generation in 2019.

Infrastructure investment carries its own set of political and regulatory risks. As government apply increasing pressure on monopolies, investors cannot expect returns to rise forever.

“There is a growing appreciation that these assets play a pivotal role in the day to day lives of society and as such, eye-watering annual price increases and under-investment in assets can no longer continue,” says Anish Butani, director in the private markets practice at Bfinance. “Fund managers must ensure they do enough to keep their ‘licence to operate’ these assets.”

Liquidity concerns bite as buyout nears

One particular concern is illiquidity. While many alternatives require investors to lock up capital for extended periods of time, set-up costs and an poorly formed secondaries market mean infra investors are in for the long haul.

This is not normally a problem for long-term asset owners like pension funds. However, with recent uplifts in DB funding, many schemes are now closer to buyout than they previously thought. With insurers usually refusing to accept infrastructure assets, mature plans may be well advised to avoid the asset class.

“Those that are still in and who are thinking ‘we need to get out’ will probably find that difficult in the short term,” says John Walbaum, partner at consultancy Hymans Robertson.

Source: Mandatewire

He expects schemes nearing buyout in the short to medium term to prefer alternatives like private debt, which typically involves a shorter time frame. “You can essentially extend it on a loan by loan basis,” he says.

Some schemes have opted for a blend of both. Last year the £9.4bn British Coal Staff Superannuation Scheme announced its intention to see almost £500m of its assets invested in UK infrastructure. It also increased its private debt target allocation to 14 per cent of assets.

Of course, if a scheme does not plan to wind up soon, infrastructure assets can provide the inflation-linked regular payments demanded by a cash flow matching strategy.

“There are lots of schemes that will expect to be around in 20 years’ time as well,” says Mr Willis.