Written By: Susan Martin
Susan Martin from the London Pensions Fund Authority makes the case for collaboration when it comes to infrastructure
With parliament well underway, it is worth taking a moment to reflect on the UK public pensions landscape as it currently stands and to set out how we at the LPFA see opportunities for local authority pension funds to benefit from infrastructure investment.
If we are to solve the under-funding that is the blight of many public sector pension funds, we believe that LGPS funds need to invest more widely, in higher quality assets and with more regard to the long term. We must consider a wide range of assets, including infrastructure and private equity, but also improve our strategic approach, for example through “buy and hold”, which takes a long-term approach to investing in large corporate stocks. With deficits as they are, we need to learn from those pension funds that are leading the way in infrastructure investing.
Take Canada’s largest public pension funds, for example. They manage around £390 billion between them. Their investment strategy is geared heavily towards infrastructure and property as opposed to publicly traded stocks and bonds. While in the US major public pension funds allocate around five percent of their portfolios to major infrastructure investment. Closer to home, the Universities Superannuation Scheme, Greater Manchester Pension Fund and we are all investing in infrastructure, and many more would like to.
This is something that UK funds should not just want to do, but have the opportunity to do. The UK government has made it clear that infrastructure investment is required and is a key driver of economic growth. George Osborne used his speech to the CBI in May to say: “Our physical infrastructure is not nearly good enough, and previous governments ducked the difficult decisions. In this Parliament we are going to legislate for and start building…”
Some of the investment for UK infrastructure projects is being sought from abroad. For example, at the time of writing a third of Britain’s trains are set to be sold to Australian and Abu Dhabi investors. These funds, and many others, see the returns and the quality of UK infrastructure investments.
After years of near zero rates, investors are looking to real assets for return and income. For example, in December the Norwegian Ministry of Finance asked its sovereign wealth fund manager, Norges Bank Investment Management, to weigh up unlisted entities as a way of allowing the country’s wealth to help fund infrastructure. This is a £700 billion fund that claims ownership of 1% of all equities worldwide and 2.5% of those listed on European exchanges. Clearly its desire to increase its investments in infrastructure should be a signal of the sector’s attractiveness.
Pension funds are in an enviable position in being able to purchase infrastructure assets that produce higher yields at a time of ultra-low interest rates, sluggish growth and ongoing uncertainty. Sadly, LGPS funds are rarely getting the opportunity to participate, and thus UK pensioners are not getting the benefit from funding investments such as these. There have been some success stories, such as Greater Manchester’s Airport City. In addition, we recently witnessed Lancashire County Pension Fund bidding for the government’s stake in Eurostar. The fact that Lancashire County Pension Fund went toe-to-toe with larger international funds on UK assets should be the norm; it should be celebrated as a step in the right direction, both for the infrastructure that it could finance and for the UK pensions fund members it provides a future for. LGPS funds need to learn from our peers and competitors, and seize the opportunities that are presenting themselves.
The LPFA right now has approximately 70 members over the age of 100, and our liabilities stretch far into the future. Indeed, many of our current members will be receiving pensions in the next century. When you think about it in those terms, you realise our investment focus needs to be a real long-term, strategic approach to identify and invest in quality assets.
Infrastructure investment not only provides a return over the long term, it also provides us with a liquidity premium. This means we essentially receive “more for our money” because the money is committed for a longer period of time. With a detailed understanding of our liabilities and when they fall due, we are able to seek this liquidity premium safe in the knowledge that we are investing amounts that we do not need to access for some time.
Looking at the LPFA specifically, examples of possible investments include operational and greenfield projects like airport expansion or debt and equity investments. From a sector perspective we are interested in transport, housing, commercial real estate and regulated assets such as transmission or utility companies. We also invest through funds, secondaries and club deals. Investing directly is attractive as it lowers costs and gives control. However, commitment and resource is required to do this.
Larger funds have the resources to pursue more complex liability driven investment strategies, focusing on matching future cash flows to future liabilities, hedging exposure to changes in interest rates and inflation, and offering significant additional flexibility and capital efficiency.
At the LPFA we have built a team of specialist investment professionals for just this reason. We believe that building our internal investment team affords us the opportunity to invest in asset classes such as infrastructure and illiquids, which would otherwise be more difficult for us to access. This strategy, along with matching our assets and liabilities while managing our costs, assists us in our long-term goal of closing the funding gap and ensuring all our pensions will be paid as and when they fall due. It also means we are, more than ever, actively managing our fund and closely monitoring fund managers with whom we work. Not all LGPS funds can make this level of investment in their teams. As we know, the UK’s pension fund industry is fragmented; few smaller pension funds have the resource to make major long-term investments in new roads, railways or airports. What we face in the LGPS now is the issue of how we can build economies of scale in order to break away from having to invest in “safe assets”.
Fortunately, there is a growing momentum for structural change within the LGPS. Many funds have taken things forward themselves, using shared arrangements to deliver benefits through reduced costs, increased access to relevant expertise and improved quality. At the LPFA we have announced both an asset and liability management partnership with Lancashire County Pension Fund and a joint infrastructure programme with Greater Manchester Pension Fund. We see both as initiatives that other funds can, in time, work with us on. At the same time, London Councils has formed a Common Investment Vehicle. They are doing so for the same reasons: to achieve economies of scale, significant cost savings and to improve access to alternative assets that may be beyond each individual fund.
The case for making investments in asset classes such as infrastructure is clear. We can seek returns that match our liabilities, provide an economic and social return for the UK – as well as smarter strategic asset allocation across the LGPS – and reduce our deficits. To achieve this we must first speak to each other, form partnerships, collaborate on opportunities and work together in order to be able to play on a bigger stage.