Written By: Matthew Craig
Infrastructure investment is of particular interest to the LGPS now that pooling is well under way. Matthew Craig looks at how local authorities can avail of the opportunities in the asset class
Synchronicity is a term first used by psychologist Carl Jung for events that are meaningful coincidences. Perhaps it can be used to describe the fact that pension fund demand for infrastructure assets is rising at exactly the time that there is a pressing need for new sources of capital to invest in infrastructure projects.
So it is not surprising that there is a trend for many investors, such as members of the Local Government Pension Scheme (LGPS) to allocate more to infrastructure. Peter Wallach, head of pension fund investment at Merseyside Pension Fund, said: “We have a strategic allocation of 6% to infrastructure of which 5% is committed and much of that is already at work. We are continuing to build out our in-house infrastructure portfolio selectively.”
Wallach said that Merseyside and the other members of the Northern Pool, Greater Manchester and West Yorkshire, share a commitment to infrastructure in asset pooling. “The Northern pool is very advanced in terms of the pooling of infrastructure, as the three funds are investing collectively through GLIL (GMPF & LPFA Infrastructure LLP, as originally set up), along with the Local Pensions Partnership (LPPI).” He added that the GLIL now has nearly £1.3 billion in commitments, of which £430 million is at work which will shortly increase to more than £600 million. And from March 30th this year, the GLIL has become FCA regulated, so that other institutional investors can join it to invest collectively in infrastructure. “For us, it is very much a vehicle for direct investing in infrastructure, enabling us to keep costs down. It also means we can invest in long-dated infrastructure assets with like-minded investors and are not tied to a typical 10-year life limited partnership. The Northern pool has a stated ambition of investing 10% in infrastructure,” Wallach commented.
Infrastructure encompasses a wide range of assets. Transport in the form of toll roads, railways, ferries or trams, or airports are one form of infrastructure. Energy and power transmission is another sector, covering power lines to wind farms or solar energy plants. Water supply and waste disposal is also part of the infrastructure spectrum. Social infrastructure covers schools, hospitals and housing, while telecommunications, including the next generation of internet broadband (5G), is another part of the asset class.
While infrastructure assets help support and maintain a modern economy, they can be paid for in different ways. Some assets pay out income in proportion on their usage, such as a toll road, which means that realisation of the projected income depends on factors such as the accuracy of usage forecasts and the overall business climate. Other assets are regulated, with governments intervening to set prices for users and investors, giving a clearer view of future incomes, although investors may be more exposed to political and regulatory risk. Overall though, investors like the long-term nature of infrastructure and its ability to generate a stable, low-risk income, which may be inflation protected to some degree.
In terms of his expectations, Wallach said: “I would expect the yield from infrastructure to be in the same area as from property. There are a lot of cross-over characteristics, but regulated infrastructure brings greater certainty. The initial yield may be lower, but with a degree of linkage to inflation and economic growth, on a 5-10 year view, infrastructure should give a decent yield in the fullness of time. 5% would be a ballpark figure, rather like property with a strong covenant, but lower than secondary property assets which have significantly less certainty about returns.”
Some infrastructure assets, such as renewable energy assets, may tick a box for investors looking to move away from fossil fuels and towards supporting a low-carbon economy. In fact, GLIL’s direct investments now include an onshore Scottish wind farm, as well as investments in rolling stock, biomass and water. Wallach commented: “Being able to invest directly in infrastructure is the biggest change for us, since fees are significantly lower as we are not paying anyone a management or a performance fee. That means the cost of GLIL is substantially lower than any of our other infrastructure funds, estimated to equate to 25-40bps on an ongoing basis.”
At the top end of the infrastructure market, there is plenty of competition for high-profile “trophy”, such as major transport links. The big Canadian and Australian pension funds are avid infrastructure investors, as large as some of the largest sovereign funds, and the latter may be willing to pay top dollar, pushing up prices. Nevertheless, Wallach believes that this should not necessarily discourage LGPS funds: “The price paid is important but, to a certain extent, it washes out over time, particularly if the fees being paid are considerably lower. GLIL typically seeks stable cash flow businesses providing a predictable cash yield and benefits from the expertise and operational benefits of investing along with other institutional investors.” He added that while trophy assets are expensive, there are also opportunities in smaller assets, further up the risk scale. “There is a trade-off between core infrastructure and higher returning infrastructure projects.”
A desire to see greater investment in infrastructure was one reason for the UK government to push for LGPS asset pooling, as this would create larger investors better able to enter the asset class. However, Local Government Association head of pensions, Jeff Houston, said this has subtly changed. “There has been a marked changed in emphasis from the government on the need for LGPS investing in infrastructure. At one point, they wanted to see a target for pension fund investing in infrastructure, if they could possibly do so.” The government has backed away from this, Houston added, although the new minister for local government, Rishi Sunak, has a vision for local authorities to invest in house building and infrastructure.
In this regard, housing is an interesting asset, as it could arguably be real estate rather than infrastructure. However, Hearthstone Investment Management partner & director – investor relations, Cristoforo Rocco di Torrepadula, believes that the private rented sector (PRS) can be considered infrastructure, saying: “I believe that PRS should be seen as a key component within infrastructure on the basis that housing investments and urban regeneration projects depend on much the same factors and drivers such as economic growth, employment, and the various components of social/community infrastructure such as transport, schools, medical and retail services. Institutions will not invest unless all of the social infrastructure components are there as well.”
There are strong grounds for considering PRS in any case, di Torrepadula added. Residential property is an established asset with many North American and European investors. “We see local authority pension funds as ideal investors in this asset class. Many are taking money off the table in equities as funding levels have greatly improved, and they need stable income streams. PRS is a low volatility asset, which helps with de-risking when bond markets are unattractive. I expect to see allocations to PRS increase and head towards the North American/European benchmark of 20% of the overall real estate allocation.”
While investment in housing is likely to start in the UK, the asset pools may invest globally in infrastructure to obtain the benefits of diversification. In this case, it is likely that they will want to use managers, rather than investing directly. Wallach commented: “In most overseas markets and certainly if investing in developing countries, such as China or India, we would undoubtedly use a manager.”
Taking everything into account, we can expect to see greater LGPS investment in infrastructure over the long term, once the new asset pools are fully operational. Funds are likely to look at a wide mix of UK and overseas assets, with a view to finding the right mix of long-term stability, a predictable income, inflation protection and a sustainable edge, if that can be achieved. But this may take time to happen, as assets at underlying LGPS funds are absorbed into pools, unless more LGPS funds decide to support existing infrastructure vehicles such as the GLIL fund.