GLOBAL - Institutional investors' allocations to infrastructure will have grown by nearly 370% over three years by 2012, according to First State Investments.

First State's recent survey of institutional investors, including pension funds, predicts that infrastructure allocations over a three-year period from 2009 to 2012 will increase by 367%.

The asset manager said pension funds have been boosting their allocations to the asset class since 2009 for three chief reasons.

First, it can hedge against inflation. Second, it can reduce volatility and increase risk-adjusted returns. And third, it can enable pension funds to match liabilities with assets, thus matching well with a liability-driven investment (LDI) strategy.

Jeffrey Altmann, director of European infrastructure investment management at First State, said: "Some infrastructure assets - such as toll roads and utilities - provide an inflation hedge, which is something that is highly valued by pension funds. The fact those assets are well regulated is also a very attractive feature."

He said the move by pension funds was part of their aim to diversify portfolios by acquiring alternative assets, which have shown low correlation with other asset classes over time.

Regionally, Europe remains the most attractive market for developed infrastructure. First State estimates the current value of developed infrastructure in Europe at €4.6trn and expects it to grow by 10% per year to meet construction, upgrade and maintenance requirements.

Altmann said: "We see several drivers in Europe that help to increase the supply of deals in this market relative to other markets, such as fiscal constraints on both governments and companies, mandated divestiture of certain assets by the EU Competition Commission and strategic repositioning of corporates."

This supply has in turn created an important space for institutional investors, which have been looking to increase their allocation to infrastructure - either adopting a direct investment strategy or adopting an indirect strategy through infrastructure funds.

However, First State stressed that fund managers needed to understand what drove this investment focus for pension funds from both a risk/return and an inflation linkage perspective.

"From the point of view of investors, pension funds also need to find out what they are looking for before allocating to this asset class and to determine what type of total return and/or cash yield a fund manager can provide," Altmann said.