Lack of funding for infrastructure projects is harming growth prospects in many developed nations. Yet with pension funds ready to offer long-term capital to reinvigorate infrastructure, the time for pension-public partnerships has come, says Duncan Symonds.
The most recent report card from the UK’s Institution of Civil Engineers gives the UK between a ‘B’ and ‘D-’ for its infrastructure.
The report ranges from assessing local transport as ‘at risk’ and in need of greater maintenance, to passing the country’s water and strategic transport network, deeming both able to cope with current demand.
But the institution’s assessment across even the highest-scoring sectors says these require further investment to keep pace with growing pressures placed on infrastructure.
The UK government estimates the public and private sector will need to invest £600bn to 2027 to meet its self-imposed target of 1.2% of GDP spent on infrastructure. Projects contained within 2017’s National Infrastructure and Construction Pipeline only amount to £460bn.
These staggering amounts are needed to repair and improve the UK’s roads, rail and digital highways. It is notable in two of these three areas – rail and roads – the UK’s rating for each sector lags behind its overall infrastructure ranking.
At present, the country’s infrastructure ranks 11th out of 137 countries, as assessed by the World Economic Forum’s Global Competitiveness Report 2017-18. Decades of underfunding means much of the UK’s essential infrastructure needs significant investment.
While there is widespread agreement that trillions of pounds are needed, greater involvement from the private sector must address the shortfall. And some inspiration may come from Australia, which is progressively closing its own infrastructure funding gap by tapping the funds tied up in compulsory retirement savings.
Globally, there is a growing realisation pension fund capital can address this issue. As noted above, investment in infrastructure has long been favoured by Australian pension funds, as well as Canadian ones. Allocation to infrastructure in Australia’s case is roughly 4%.
By comparison, the Pensions and Lifetime Savings Association estimated in 2013 – when the UK government first began encouraging the sector to consider infrastructure – that allocation varied between 2.1% and 0.2%, depending on whether the defined benefit fund surveyed remained open to new accrual.
In Australia, retirement savings are used not only to fund long-term infrastructure assets but also to buy old infrastructure – showing the benefits of pension-public partnership and asset recycling. Asset recycling is particularly beneficial, unlocking capital for government to reinvest in infrastructure maintenance or new infrastructure.
When IFM Investors first partnered with the 10 local council owners of Manchester Airports Group, their growth aspirations were readily apparent. Our partnership with the group allowed it to acquire Stansted Airport in 2013, and it has since begun renovating Manchester Airport.
The £1bn transformation programme, now well under way, will improve the customer experience for the airport’s 27 million yearly passengers, opening up new routes to one of Europe’s busiest airports.
The virtuous cycle
One unique benefit of pension funds investing in infrastructure is that these transactions create a virtuous cycle.
Take asset recycling, for example. Ownership of old assets is transferred from the state and taxpayers to workers through their pension funds. The government can then plough some or all of the proceeds back into infrastructure – benefitting the wider community.
The virtuous cycle delivered by this pension capital-led asset recycling is not lost on Australian taxpayers. Independent research conducted in 2014 by Industry Super Australia, the industry association for the not-for-profit pension sector, found community support for privatisation was only 13% when an asset was sold to short-term investors such as investment banks, but 75% if the new owner was an Australian pension fund.
Infrastructure as an asset class tends to be attractive to pension funds for several reasons.
First, unlisted assets such as infrastructure have historically outperformed listed equity over the short, medium and long term, as shown by an extensive study conducted by EDHECinfra, a benchmark provider, comparing performance over a 16-year period to 2016.
The cash flows associated with core infrastructure’s monopoly characteristics and inelastic demand curves may also appeal to pension investors. By comparison, the performance of other major asset classes such as shares and credit tends to be heavily influenced by financial market dynamics and investor sentiment.
For pension funds, strategic ownership of infrastructure assets reduces the costs associated with financial intermediaries that take a cut when an asset is offered through a listed financial instrument.
Ownership can also give pension funds more control over the management and development of the asset, maximising economic value.
Pension funds are uniquely placed to sustain relatively illiquid investments such as infrastructure. Their members’ long-term investment outlook aligns with the long-term life-cycle of such investments, better aligning pension funds with community and government expectations.
Investment in economic infrastructure is integral to driving productivity and economic growth. Maintaining and expanding core infrastructure is therefore vital to developing and developed economies alike.
Both need to improve or maintain current productivity, often while preparing for significant demographic changes. Infrastructure investment improves the quality and quantity of a nation’s capital stock, keeping the wheels of an economy moving even with an ageing population.
A good example is the construction or upgrade of a road that relieves congestion. Better connectivity quickly reduces costs for businesses.
Such investments may also yield dynamic productivity gains that arise from the better integration of markets. At a macroeconomic level, infrastructure investment contributes to capital deepening of an economy.
This in turn should lead to economic growth and higher real wages.
A growing appetite
In the case of the UK, it is well placed to take advantage of pension-public partnerships through long-term, responsible owners and the benefits of asset recycling.
In the past decade, UK pension funds have become more aware of the benefits of investing in infrastructure. The eight asset pools established through the Local Government Pension Scheme (LGPS) are all interested in increasing their allocation to infrastructure – some have already started shifting.
In an increasingly uncertain investment environment – looming trade wars, pervasive low interest rates – core infrastructure can offer downside protection not traditionally associated with equities.
Additionally, careful stewardship of infrastructure can improve opportunities and employment outcomes for the wider community, equating to a social and an economic good, created by the long-term, patient pension capital invested.
Duncan Symonds is director of asset management, EMEA at IFM Investors, a global fund manager with £59.7bn in funds under management across infrastructure, debt investments, listed equity and private equity as of 30 June 2018. Established more than 20 years ago and owned by 27 major pension funds, IFM Investors’ interests are deeply aligned with those of its investors.
The information contained in this article should not be construed as investment advice or any form of financial opinion or recommendation.