The big opportunities lie in infrastructure, housing and ‘emerging’ sectors. UK funds have spotted this and are scaling up accordingly. Richard Lowe reports
The UK government has been seeking to plug its infrastructure ‘funding gap’ for some time. The simple solution, it would seem, would be to match the billions of pounds needed to regenerate the built environment with the billions in pounds managed by the country’s pension funds. But in reality, finding a perfect match is never easy.
Perhaps what was needed was the institutional investment equivalent of speed dating. These were the words used by Bristol Mayor George Ferguson when describing a recent government-hosted event where the leaders of three UK cities were put in front of 50 UK and international investors.
The Downing Street Investment In Cities event was hosted by cities minister Greg Clark and Lord Deighton, head of the ‘growth task force’ for the high-speed rail network HS2. Representatives of Bristol, Leeds and Birmingham – including Ferguson – were given 10 minutes to pitch investment opportunities with five minutes for questions from large institutional investors.
One of the speed daters was UK insurer Legal & General, which used the event to announce its intention to create a £15bn regeneration fund to invest in UK infrastructure and housing. Most of the capital will have to come from third-party investors, but Legal & General has committed £1.5bn (€2bn). The fund will collaborate with the government’s Regeneration Investment Organisation (RIO), which had sponsored the Downing Street gathering.
The news came days after Legal & General’s investment arm announced it was restructuring part of its business by bringing two separate disciplines – infrastructure and real estate – under one roof. Bill Hughes, the CEO of L&G Property, was appointed head of real assets.
Housing: building from scratch
Legal & General’s multi-billion-pound fund includes housing within its ‘regeneration’ remit. Hughes says it will focus on “shovel-ready” housing projects, while Legal & General will continue to invest more widely in residential markets. “There is a weight of capital that wants to own institutional quality” private-rented sector (PRS) housing, but the stock does not exist. Legal & General has the capabilities to build it, he says.
Unlike many continental European countries and North America, housing is not an established institutional asset class, conducive to big-ticket investments. For this reason it is taking its place alongside a number of other alternative or niche property sectors – including student housing and healthcare – that are attracting increasing attention from institutional investors.
Hughes prefers the term “emerging sectors”, which implies their maturing will be inevitable as a result of unstoppable demographic and social change. “Because they are emerging, there is a potential positive re-rating in terms of how they are priced,” he says. “Because they are emerging, there is less competition.” These factors support the case for long-term outperformance, he argues.
Hughes estimates that 4% of Legal & General’s exposure used to be in these emerging sectors, but in recent years it has allocated approximately a quarter. He does not see why the IPD benchmark for the UK will not one day have a similar weighting.
“The fact that IPD has been historically 95-98% retail, offices and industrial tends to have promoted a status quo situation where property investors invest only in those sectors,” Hughes says. “So L&G, as of three years ago, proactively said we don’t want to be a slave to the benchmark – there are better investment opportunities around in the UK.”
The big, so-called ‘gatekeeper’ investment consultancies have long been blamed as a crucial supporter of that status quo. Real estate fund managers often bemoan the constraints put on them by benchmarking practices – although they refrain from complaining publicly.
But this too could be changing. “We are being proactive in telling our clients to be less IPD-constrained and to consider more alternative property sectors,” says Paul Jayasingha, senior consultant at Towers Watson, one of the aforementioned gatekeepers. “Having strategically higher weightings to industrial, some retail and alternative sectors and a lower weighting to offices makes more strategic sense if a client is thinking in absolute terms.”
The challenge is this means employing more specialist managers. It can also take longer to deploy capital in any significant scale. But, Jayasingha says, “from a very high-level, strategic sense, the idea of defaulting to a peer-group index that’s gone to higher weights in offices and retail just doesn’t make sense to us.”
PRS has been top of the list of alternative sectors for some time, due to the favourable demographic and supply-demand shifts taking place in the country. Some of the first movers have been foreign investors, including some of the large Dutch pension funds.
M&G Real Estate, the real estate fund manager of Prudential, launched a new residential fund 18 months ago. Seeded with capital from the M&G Life Fund, the new vehicle first attracted Dutch investors and is close to securing Danish institutional capital, according to fund manager Alex Greaves.
He says: “The first question they ask me is: why aren’t the English investors doing this? They don’t understand why we haven’t done it earlier. They say, but you’re supply-demand dynamics, your population growth forecasts, your economy, your lack of space – all of these things point to it being a very strong opportunity.”
But, again, things are changing. The fund is now attracting UK pension funds, some of which are coming via real estate multi-managers.
The M&G Residential Fund has £140m (€189m) in assets but is expected to grow. Greaves agrees that the way in which funds like these perform over the next few years will be instrumental in whether UK pension funds really will become significant holders of housing stock. “Absolutely,” he say, “because we are at the early stages of a relatively new sector from an institutional point of view.”
“Regeneration is about a combination of infrastructure and real estate, which collectively makes up the built environment,” Hughes says. “So it is entirely coherent that we have made the change that we have – to have a real asset division – prior to the regeneration fund announcement. The totality of the team that reports to me will underpin Legal & General’s involvement in the regeneration fund.”
As Hughes explains, Legal & General believes in investing in the regeneration of the UK. “For the UK to unleash its potential and for the UK to grow, a lot of that will be about infrastructure and infrastructure investment, and a lot of the by-product of that will be about real estate and improving real estate markets. That will manifest itself in lots of ways but including – in our view – the renaissance of lots of significant urban areas outside of the Southeast. So it makes a lot of sense to have people looking at the universe of opportunities both across infrastructure and real estate.”
The real estate and infrastructure teams will still operate as discrete businesses, managing separate funds and mandates, but their alignment reflects an important shift in how investors are beginning to look at real assets, whether it be property, infrastructure or forestry. It is also logical at a time when ‘alternative’ property sectors – including various forms of housing and social infrastructure – are becoming increasingly popular and are blurring the lines between real estate and infrastructure.
Hughes gives three principal reasons for the approach. One is a recognition that investors are often attracted to real estate and infrastructure for similar reasons. The second is the operational benefits, including business and strategic efficiency.
But the most interesting reason concerns the blurred-lines point. “In all sorts of ways, we think that property and infrastructure are becoming more entwined,” Hughes says. “They are necessarily coalescing and adjacent such that it makes sense to be thinking about both at the same time.” He cites Crossrail and the various property developments that will be needed to support the rail network’s new stations.
Local authorities scale up
The week before Legal & General announced its plans for a real assets fund, two local authority pension funds announced the launch of their own. The new joint venture between the London Pension Fund Authority (LPFA) and Greater Manchester Pension Fund (GMPF) will invest predominantly in UK infrastructure – as well as related assets such as property – with a focus on the London and Manchester areas.
At £500m, the fund is much smaller than Legal & General’s, but it is another example of UK institutional investors beginning to work together to build scale. The £5bn LPFA is also looking to merge its investment activities more widely with the Lancashire County Pension Fund, potentially creating a £10bn pension fund investor. Should the two funds go ahead with their ‘asset-liability management partnership’, Lancashire would end up being exposed to the new joint venture with GMPF and – theoretically speaking – could provide more capital. The fund will also be open to other third-party investors in due course.
The Pensions Infrastructure Platform (PIP) – set up by the National Association of Pension Funds (NAPF) and the £23.4bn Pension Protection Fund (PPF) – is the first example of UK pension funds pooling capital to target the asset class. The LPFA was one of a number of founding investors in PIP, but – along with the BT Pension Scheme and BAE Systems – has exited the platform over investment costs and return expectations.
And while the LPFA has teamed up with Manchester and Lancashire – and is courting other local authorities – 28 London local authority funds have come together to create a city-wide collective investment vehicle. While this fund is not explicitly targeting infrastructure, the inferences have been made.
There is no coincidence that this move towards collaboration and building scale has emerged when the infrastructure asset class looks set to become a much more important and sizeable element of pension fund portfolios the world over.
“Infrastructure is definitely one of those asset classes where I would believe scale helps,” says Chris Rule, who took over from Alex Gracian as CIO of LPFA late-last year. “Both [LPFA and GMPF] are reasonably large already, but if you think about it, some of the large, core infrastructure assets – the equity value you are looking at is easily getting up to the £100m mark and considerably more in some cases.”
The LPFA has allocated 5% of its £5bn of assets to infrastructure. The collaboration with GMPF effectively doubles the volume of capital that could be directed at the asset class. “Five percent of a £10bn pool obviously starts to provide a bit more scale to make sure we can do those projects while maintaining some diversification. That was also in our thinking in the partnership with Manchester.”
Councillor Kieran Quinn, chair of the GMPF, admits that the local authority fund is “not even a midge compared to” some of the world’s sovereign wealth funds. “We accept that, but we have to start somewhere,” he says. “Half a billion pounds is a decent pot to start with.”
He adds: “Clearly, when [Chancellor] George Osborne was looking for support around HS2 he didn’t approach one local government pension scheme, he didn’t approach the funds to work collaboratively. Is that his fault for being too focused on China and elsewhere? Or is it our fault for not having given the opportunity to look towards us? I don’t know. So let’s start to create the impetus that will ultimately lead to something significant in size and scale that will mean that when it comes to UK infrastructure investment we might not be the first organisation that government turns, but we will be in the first two or three.”
Underpinning the moves is a belief that institutional investment in UK infrastructure can support future growth of the UK and generate strong returns – the ultimate objective of these funds.
“I believe the two co-exist equally together,” Quinn says. “I believe that the opportunities to afford us a commercial return exist exactly in the areas that we require social and commercial and industrial regeneration. This is a commercial opportunity. The expectation is of good commercial returns.”
Hughes says: “It is backing the UK as an economy.” He add: “This moment in time is particularly about us showing our conviction to really make things happen. We are not waiting for new regulation, we are not waiting for the government to be especially supportive. We just believe in this. We have capital to deploy and we are going to get on with it.”
Looking down below
Quinn reiterates the point he has made publicly before. “One of the frustrations I have is other countries are far more advanced than us at the use of pension funds for infrastructure opportunities,” he says, referring not just to Australia and Canada, but also some of the Nordic countries.
The pooling pension fund assets and resources to invest in infrastructure – and compete with sovereign wealth funds – is not a new science. Australian pension funds have a much longer history of investing in infrastructure, both domestically and internationally.
IFM Investors, for example, is owned by 30 Australian pension funds and was one of the first movers into the asset class in 1995 when the Australian government began to privatise infrastructure assets. It manages two open-ended infrastructure funds, investing in Australia and global markets, respectively.
“In all sorts of ways, we think that property and infrastructure are becoming more entwined”
“Five percent of a £10bn pool obviously starts to provide a bit more scale to make sure we can do those projects while maintaining some diversification”
It has begun to bring international investors into its funds, including – in recent months – three UK pension funds: the City of London Corporation Pension Fund, Leicestershire County Council Pension Fund and the Avon Pension Fund.
“The whole concept of pension funds collaborating to build an infrastructure asset management business is something we are sympathetic to,” says Brett Himbury, CEO of IFM Investors. “That’s how we came about nearly 25 years ago.”
While Himbury thinks “it’s a great model, clearly”, it throws up challenges along the way. “It’s really hard to get a group of different pension funds to come together and agree. What are their return objectives? What are their processes? What are their risk profiles?”
Himbury says IFM Investors is talking to a number of UK investors that are looking into building scale to invest in infrastructure. The Australian group’s line is: why try to build it when you can align yourself to something that has been 20 years in the making?
IFM Investors owns a 35.5% stake in Manchester Airport Group (MAG), which it acquired from GMPF in 2013. The investment enabled MAG to acquire Stansted Airport.
“The partner was IFM, who have a tracked record of 20-plus years and they are a collaboration of the Australian pension funds,” Quinn says. “But where was the UK equivalent of that?”
He adds: “Manchester Airport Group weren’t just looking for money. They were also looking for a partner with experience. The two go together. That is why the fact that we have a great relationship with the LPFA means that I do see this developing as a long-term relationship and one that will develop into hopefully a UK version of that. But that’s 20-plus years.”
Investor Universe: UK funds look to scale up
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Investor Universe: UK funds look to scale up