Building steadily: what next for infrastructure?

By Padraig Floyd

If anything in the world of investment management can be said to have been a cause célèbre in the last year, it would have to be infrastructure investment.

We have got to get past the fear pension funds have about greenfield investing. If you think we have problems, the US needs to spend $1trn on roads and bridges in the next three years.

Alan Rubenstein

Chancellor George Osborne, in his current role of Old Mother Hubbard, made it clear that unless the government made it easier for investors – in particular pension funds – to access infrastructure investment, the poor doggie would not get a bone. And we, as a society, would have to do without schools, hospitals, roads and more.

If you ask someone who does not already invest in infrastructure about it, you’ll generally get a sharp intake of breath accompanied by comments about it being too expensive, too risky and only for the big boys.

This is not only received wisdom, but also to a large extent perfectly true. Even large schemes get jittery when thinking about infrastructure, because it is complex, highly-specialised and they simply do not understand it. Under those circumstances, any form of investment is going to look like playing at the casino.

PIP, PIP hooray!

Those who do get it or are keen to dip their toe in the water often have not got the scale to be able to achieve it on their own, but there is considerable demand, says Alan Rubenstein, chief executive of the Pension Protection Fund (PPF).

It is for this reason the PPF has launched the Pensions Infrastructure Platform (PIP) – to provide pension funds with access to infrastructure assets.

“Schemes are keen to invest in infrastructure, but people don’t like the structure of what is being offered,” says Rubenstein. PIP intends to address what Rubenstein calls “key failings in the infrastructure market from the point of view of pension fund investors”.

It starts with fees, as many existing funds are modeled on private equity with fees around two and twenty (2% + 20% of profits) though some can be had for less. PIP will target target fees of 50bps with no carry, because the traditional fee structure “demonstrates an asymmetry of interests between those running the funds and the pension funds”, says Rubenstein.

Long term, low risk

“Pension funds want long term, low risk investments, but structures are often relatively highly geared and there is an assumption the managers will run it, sell on and lock in the gain,” adds Rubenstein.” Many funds have only a 10-year life, and the perception is there is a temptation to turn things over, whereas pension funds want to hold assets for 25 to 30 years.

The demand is strong because defined benefit schemes are looking for matching assets and at the moment, gilts and other indexlinked bonds are expensive, says Rubenstein. PIP already has nine schemes signed up with one or two others in the wings. One of those to commit to the PIP – subject to a few conditions being met – is the £9bn West Midlands Pension Fund.

The scheme is no stranger to infrastructure investment, having established a 3% allocation five years ago. While the move towards infrastructure is making slow progress, greater access won’t make it plain sailing for schemes. You still need to spend a lot of time researching the market and determining just what type of infrastructure is right for your scheme, says Kevin Dervey, senior investment manager, non-equities, West Midlands Pension Fund.

“We talk flippantly about infrastructure, but it is a big subject area. You have to be comfortable with your investments. “Aside from core infrastructure, we like green/clean fuels,” says Dervey. “But we are not big fans of PFI. We’ve done it in the past and we struggle to see the value in, for instance, affordable or social housing.”

An appetite for debt

USS, the £32bn pension scheme for UK academics, is also no stranger to infrastructure. It currently has 2.5% – around £900m – invested, but is restructuring its portfolio and has a short term target allocation of around, what Mike Powell, USS’s head of alternatives calls, “a buyer’s outlook” for the next few years.#

USS has been successful with infrastructure and sees opportunities, so has increased its internal capacity with a couple of hires and is more active in a small number of transactions, particularly in the UK.

Some of this is in infrastructure debt, a new and exciting element of the infrastructure market. “UK infrastructure companies are# looking to diversify their debt funding sources and are very interested in new entrants such as USS as some of their traditional sources are constrained either by concentration issues or impending regulation,” says Powell.

A diversifying market

There has been a considerable increase in debt issuers from outside the traditional regulated infrastructure environment looking for long-dated capital markets finance, according to Alan Parry, managing director, secured debt markets, RBS.

This includes UK ports, rail concessions and even companies like Center Parcs, that can demonstrate infrastructure-like stability of cashflow. Borrowers have also sought to continue diversifying their funding sources in 2012, says Parry, with increasing use of the private placement market and the first investments from the new universe of infrastructure debt funds.

“Another trend we expect to see strengthen in 2013 is the increasing channelling of long-dated pension fund money via the new universe of infrastructure debt funds,” says Parry.