“The longer term future of OECD economies, and indeed the global economy will depend to an important extent on the availability of adequate infrastructures to sustain growth and social development. Through to 2030, annual infrastructure investment requirements for electricity, road and rail transport, telecommunications and water are likely to average around 3.5% pa of world gross domestic product (GDP).” – Organisation for Economic Co-operation and Development (OECD): Infrastructure to 2030.
In this context, the UK Government created the National Infrastructure and Construction Pipeline, a forward looking assessment of infrastructure spending in the UK focussing on England. Based on the December 2016 analysis, the pipeline consists of £500bn of investment in social and economic infrastructure, with £300bn to be invested by 2020/21.
There are a number of reasons why a pension scheme would consider investing in infrastructure, for example:
- Hedging against inflation
- As a liability matching tool
- Increased ESG profile
- Taking advantage of the illiquidity premium
- Providing predictable cashflows over the longer term
WHAT IS INFRASTRUCTURE?
‘Infrastructure’ is a very broad church, but can be described as the capital projects that are used to produce and provide publicly available services. Infrastructure investments can be split into two different stages – ‘Brownfield’ and ‘Greenfield’.
Brownfield infrastructure is defined as previously developed infrastructure projects, and typically involves investing in fully operational assets where there is a track record of operation and a yield can be earned immediately.
Greenfield infrastructure investments involve investing at the development stage of a project. This can therefore include both planning and construction risk, and a yield is not earned until post commissioning of the asset. The return is expected to be higher than brownfield investment but there is greater risk, as well as a period of time where there is no yield from the asset.
Fig.1 looks at a number of different sub sectors within the infrastructure asset class, and also shows the two stages (brownfield and greenfield) on an expected risk vs. expected return basis. The chart also includes where classic fixed income and traditional equity asset classes would fit into that risk – return spectrum.
WHY INVEST IN INFRASTRUCTURE?
Diversification – The assets and returns can have low correlations with global equity markets
Inflation hedge – increases in costs priced into the income of a project can protect pension schemes against possible future increases in inflation.
Cashflows – large portions of the cashflows are agreed by contract.
Liability matching tool – predictable cashflows make infrastructure ideal for matching the long-term inflation linked liabilities of a scheme.
Social responsibility – infrastructure assets can help a scheme meet environmental, social and governance (ESG) requirements.
Illiquidity premium - capture additional expected return from locking away a proportion of scheme assets.
HOW DO YOU GAIN ACCESS TO INFRASTRUCTURE?
There are a number of ways of achieving access to infrastructure:
Equities – equities in infrastructure related companies have high correlation to equity market movements.
Bonds and debt – bond values will include market views of interest rates as well as sentiment on individual project.
Direct investment – direct funding of projects providing access to infrastructure project returns (below) and illiquidity premium.
As shown in Fig.2, committed capital (cash outlay) is deployed over a number of years, with cash inflows slowly building over this period. As such, the investment is unlikely to yield positive absolute returns until many years into the investment.
Infrastructure returns are typically stated as an internal rate of return (IRR), which is the annualised rate of return of the investment.
RISKS ASSOCIATED WITH INFRASTRUCTURE
Some of the most common risks associated with infrastructure investments are described below:
Liquidity – potentially low liquidity, with ‘lumpy’ cashflows.
Political – regulation of assets.
Reputational – for example, investing in a water company which provides polluted water to the public
Financing – use of leverage on an underlying deal-by-deal basis, introduces the risk of having to re-finance at higher costs at a future date.
The growth required across global markets into infrastructure investment offers an undeniable opportunity for the providers of capital. Pension schemes can position themselves today to participate in the long term cashflows and attractive risk-adjusted returns offer.
To discuss how investing in infrastructure could benefit your pension scheme please consult your JLT Investment Consultant or
John Paterson Senior Consultant, Investment Consulting | T: +44 (0) 131 203 2864 | E: firstname.lastname@example.org
Nick Buckland Senior Consultant, Investment Consulting |T: +44 (0) 207 528 4188 | E: email@example.com.