Lining up the opportunity
Pension funds and infrastructure are often described as being a perfect match. Rachel Fixsen looks at the difficulties involved in achieving such a union
You can almost hear the wedding bells ringing for pension funds and infrastructure projects. On the face of it at least, they are the perfect couple. Governments are desperate to boost growth with public building projects, while pension funds are looking for stable long-term investments.
The timing seems perfect. Bank financing for infrastructure projects is drying up as a knock-on effect of the credit crisis, exactly when pension funds need alternatives to the rock-bottom yields of their old mainstay – government bonds.
The current supply of infrastructure debt to investors is the result of Basel III rules on the ability of the banks to supply financing, according to David Cooper investment director at Industry Funds Management. “At the same time, there is demand from governments as they try to use infrastructure as a way of getting growth back into economies,” he says.
Traditionally, governments would have issued bonds to finance this, but because their ability to do this has diminished they have become more reliant on private finance. And with banks less able to provide the debt financing, governments are now having to fish in a wider pool for potential investors.
Both pension funds and insurance companies are eyeing infrastructure keenly, attracted by the stability of the assets and the yield pickup they stand to gain over government bonds, according to Philippe Benaroya, managing director and co-head of European infrastructure debt at BlackRock.
There is no shortage of intermediaries to bring the partners together and tie the contractual knot. Asset managers now offer a wide range of funds and other structures to enable institutions to invest in infrastructure.
Everyone is ready to go, but progress is surprisingly slow. So what are the stumbling blocks?
“There are opportunities for institutional investors to look at within infrastructure debt, but probably not as much as you might expect given noises from government,” says Cooper.
While politicians are vociferous about infrastructure projects in the UK – such as the High Speed 2 rail scheme in the UK and offshore wind power – many of those projects have been delayed at the planning stage and slowed by the passage of the energy bill through parliament.
“If you’re an institutional investor, it’s more a case of ‘jam tomorrow’,” he remarks.
Another potential source of infrastructure investment is in the back-book of deals on bank balance sheets, but this too is only slowly getting to investors.
“These can theoretically be purchased, but at the moment banks are generally quite flush with liquidity because of actions from the Bank of England and the European Central Bank,” Cooper observes. “Banks are quite willing sellers, but they don’t have to sell, and that constrains supply.”
Intermediaries clearly have a vital role to play, too. Are they oiling the wheels by offering institutional investors infrastructure investments in the form they really want? One industry insider says bringing offer and demand together can be complex, and it will take time for asset managers to build up expertise.
The good news, though, is that there is no lack of demand from borrowers, because they need this funding, says Benaroya. This is exactly the same in the UK as it is in northern and western Europe, he says.
However, the sheer complexity of infrastructure transactions is certainly another hurdle for those attempting to bring investment deals to fruition. “Transactions are complex to originate and to monitor,” he says. “This is private debt, so it requires access to deals; it’s going to take time before infrastructure can use the public bond format – we’re not there yet.”
Asset managers have complete many tasks to shape infrastructure investments for institutional investors. This includes deal origination, structuring, due diligence, and aggregation of capital and diversification across deals.
“You need a third party who is independent, providing that expertise and adding value,” Benaroya says, adding that this is the role Blackrock is trying to play – being a global player and giving investors what they are looking for.
While the equity side of infrastructure investment has traditionally dominated, it is the debt side that is now coming to the fore.
The solutions managers are offering to would-be infrastructure investors are still heavily focused around pooled funds, says Toby Buscombe, senior consultant at Mercer.
“Predominantly, they are still unlisted, closed-ended funds, so they are relatively illiquid,” he says. “This hasn’t changed a lot over the last five to 10 years, but one area that has changed significantly is the level of definition and specificity.”
Most funds now are far more defined in terms of sector, geography and style, he says.
“This leaves more scope for tailoring final portfolios to investors’ needs, which is important because a portfolio that makes sense for one investor won’t necessarily suit another,” Buscombe says.
Of the debt products on offer, there is a small number dealing with junior debt and others involving senior infrastructure debt. It is this latter group where interest has been strongest recently, he says.
So what kind of infrastructure investments are investors looking for today?
Buscombe sees a lot of disparity in investor aims around the world. “In the UK there’s a strong focus on the part of investors on core, lower risk investments, and across the region there is a reasonable supply of these products,” he notes.
“Against this, particularly in the UK and parts of Europe, we’re seeing some demand for even tighter geographic focus, including country-specific vehicles. One of the key reasons is that investors are becoming increasingly focused on infrastructure as a form of inflation linkage.”
Terry Mellish, business development head at Natixis Global Asset Management UK, has seen much interest from investors in infrastructure, both in debt and equities. “I think it’s a very nascent asset class,” he says. “Infrastructure is very tangible and it can provide diversification, uncorrelated returns, as well as an income stream.”
However, investors do see obstacles when taking an initial look at the asset class, such as whether to get involved in the debt or equity side, the potential start-up costs and whether they are prepared to accept the illiquidity, Mellish says.
An institutional investor considering infrastructure for the first time may not fully appreciate the wide range of different types and ways of accessing it, explains Ian Berry, fund manager, infrastructure and renewable energy at Aviva Investors.
“Infrastructure doesn’t mean one thing, just as real estate doesn’t mean one thing,” he says. “Each type has a different risk-return profile, and each one suits a different type of investor.”
Whereas infrastructure has historically been managed with a private equity approach, this does not suit the majority of investors today, Berry believes.
“They perceive infrastructure as long term, low risk with a steady yield and possibly with some inflation protection.”