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Comment: The pension infrastructure fund - three questions that need answering

21 March 2012

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Last week's announcement of a new industry-backed infrastructure platform at a National Association of Pension Funds (NAPF) conference was made with some vital elements left unexplained.

The NAPF and Pension Protection Fund (PPF's) project has been in the pipeline ever since Chancellor of the Exchequer George Osborne agreed with the two organisations to work on enticing pension money into UK infrastructure.

More noticeable than the announcement of the January 2013 launch was the lack of exact details on the fund's structure. Pension Funds Insider examines three questions that trustees need to have answered if the hopes that the government and pensions industry have in the new fund are to pay off.

 

Question 1: What incentives will be offered to pension funds?

The fund's aim to return 2-5% above RPI inflation stole the headlines, a handy looking figure without any certainty at this stage.

For one thing, many long-term infrastructure returns are heavily linked to overall economic performance, so any pension fund trustee doubtful of the UK's prospects for the coming decades might equally doubt if these returns can be delivered.

Secondly, the infrastructure fund will have to compete for pension fund trustees' attention with a glitzy array of other alternative investment options.

For instance, 'absolute return' hedge fund managers (while being controversial in their own right) are increasingly winning pension fund money with their attractive-sounding mix of low risk and enhanced returns.  

In this environment, in all likelihood reducing risk and keeping fees low will be decisive for the fund's success.

These are two areas though that have been the Achilles' heel of infrastructure funds on the UK pension market so far.

Reports suggest that charges are planned be capped at a lean 0.5%, but matching this promise will prove tough in an investment area which involves complicated projects that often smash initial budgets.  Requirements to carry out a large amount of research and diligence are another typically unpleasant cost for infrastructure investing.

Risk, meanwhile, threatens to be a real sticking point.

The government would naturally prefer pension funds to support new infrastructure projects that can get the economy ticking. Pension funds will be happier though to go for the safer option of buying debt and equity of completed infrastructure projects, particularly as most defined benefit schemes are looking to shed investment risk.

Schemes have hinted that they want the government to provide guarantees that eliminate risk before they back any new construction projects in the new investment fund. NAPF chief executive Joanne Segars says that nothing has been agreed on this as yet, however.

Pension funds may well want such a guarantee to be set in stone, with Shadow Pensions Minister Gregg McClymont pointing out that political risk dogs infrastructure investing. 

But the last thing pension funds would want is to heavily back the construction of a rail link or an airport expansion only for a new government to come in and scrap the plan.

 

Question 2: What will the platform fund exactly?

The short answer is not a lot, at least to begin with.

The £2bn which the NAPF and PPF are hoping to have in the infrastructure fund after the roll-out next year is (to say the least) a modest start.

Initial reports last autumn suggested the chancellor was hoping to attract as much as £50bn of pension money into UK infrastructure projects.

This figure was £20bn over the next decade in Osborne's memorandum of understanding with the industry, and Segars insists this is still "a long-term aspiration".

Two billion pounds would fund just 6% of the new high speed rail link between London and Birmingham, roughly 8.5 miles of track. Not enough surely to spur a national economic revival in itself, but it is a start.

PPF head Alan Rubenstein said there is likely to be a 50/50 divide between equity and debt, something that will please pension funds with a chunky bonds holding as part of a de-risking drive.

Giles Frost, director of infrastructure investing firm Amber Investment Group told Pension Funds Insider last November that many of the most attractive infrastructure investment opportunities will come in public buildings like schools and hospitals. Trustees might therefore be more keen to see these included than larger high-profile projects with potentially greater risk.

 

Question 3: How will it attract pension funds that haven't invested in infrastructure before?

A key hope of a pooled industry-backed infrastructure fund is that it can entice smaller pension funds into the asset class.

Pension Funds Online holds data that shows that the Government's plans are ambitious, with only 1.6% of the UK's top 1000 schemes invested in infrastructure to any significant level.

Larger UK funds, especially local government plans, have been more inclined to invest in infrastructure, probably because they have more resources to steer them towards the right investments in the complex asset class.

Greater Manchester Pension Fund, the London Pension Funds Authority and Hermes Fund Managers (who run the BT pension fund's investments) are likely to be providing most of the initial interest, said to number half a dozen funds ready to invest.

Waiting for smaller pension funds to see the platform benefiting larger funds before investing themselves might work. With pension fund trustees famously conservative, it could be a long time though before a large number of funds become sure of the benefits on reputation and return figures alone. 

Solid guarantees and an attractive fee structure, on the other hand, would give the drive to attract investment from smaller funds a huge head start. 

This makes it all the more urgent to tie up the detail and provide a clear breakdown of what the infrastructure fund will invest in, and how it will develop.

Another challenge is that with reports suggesting the infrastructure fund will look outside of the investment industry for management, marketing efforts might need to be headed by the government or channelled through the NAPF.

 

First published 14.03.2012

dbillingham@wilmington.co.uk