Whenever the topic of investing in infrastructure is raised, the conversation inevitably turns to the difficulties of defining an asset class as nebulous as this.

Under the broadest definition, most UK pension funds already hold investments in infrastructure without necessarily being aware that it could be classified as infrastructure.

Key points

  1. Schemes should start with their specific investment requirements

  2. There is a lack of deals and a labour-intensive bidding process

  3. Banks are less willing to pass on assets than some suggest

The asset class can include listed airport or water company debt, which may be a relatively straightforward investment sitting within an existing bond portfolio.

This will typically be where individual projects are of sufficient scale to warrant public-debt financing – typically £200m or more.

Often this will be the cheapest form of debt financing, because investors put a value on the liquidity of a public bond that can be traded in the secondary market. In most cases, the bonds are issued only once the initial construction stages have been completed and the associated risks have declined.

A typical pension scheme’s non-gilt fixed income portfolio might include 10-15 per cent in utilities and a further 20 per cent in broader infrastructure exposure through this mechanism, perhaps including listed private finance initiative bonds.

It is estimated that UK schemes have a direct infrastructure allocation of less than 5 per cent and even then it is the larger pension funds that tend to dominate.

Where to begin

Schemes should start with their specific investment requirements. For most this means generating secure and predictable long-term cash flows to match liabilities.

These characteristics are typical of directly invested infrastructure debt, and specifically of investment-grade debt. This is where most insurance companies focus, as the cash flows are more predictable and there are higher levels of security in the event of default.

In fact, debt investors are likely to receive about 90 per cent of their investment back in that circumstance. This figure is backed up by research by ratings agency Moody’s, which considers the recovery history of UK infrastructure projects to be excellent.

Schemes that want equity exposure to infrastructure can always go down the listed route, investing in the shares of large companies, and in particular those in the larger utility, energy, and transport sectors.

Additionally, investor funds can be bought from managers with in-house expertise who can finance individual projects and who may hold the equity of smaller infrastructure projects that are not listed.

Direct investment

For schemes seeking the illiquidity premium that comes with directly investing in infrastructure debt, there are a number of hurdles to overcome.

There is a dearth of deals in the pipeline, in spite of the government’s claims. The labour-intensive bidding process is also not conducive to institutional investment.

It is likely that teams of people will need to support a number of bids, and with highly uncertain outcomes a lot of costly work may go into an unsuccessful pitch.

Outsourcing might seem an answer, but schemes should be aware that fees can eat up most of the excess returns over corporate debt and therefore make this avenue less attractive. Larger pension schemes could consider assembling an in-house team to cut overall costs and develop expertise.

Banks holding back

An obvious route through this obstacle course is for schemes to buy from banks’ existing direct debt assets, such as PFI loans. The banks, increasingly constrained by new regulation, have largely stopped lending for long maturities and in theory should want to clear uneconomic loans.

Unfortunately this does not seem to be the case and they are currently unwilling to pass on these assets largely due to the resultant loss they would have to crystallise. Schemes should beware of anyone promising access to large such portfolios.

Investing in very long-term, secure cash flows is generally a good option for schemes and – as long as they remain focused on these characteristics, and do not get hung up about wider definitions – directly investing in infrastructure debt, despite the difficulties, is an option they should fight for.

Allen Twyning is an investment manager at Pension Insurance Corporation

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