Infrastructure debt investment in projects with construction risk such as private finance initiatives and public-private partnerships are gaining traction among pension funds, after initial scepticism.
Despite a growing interest in the pensions infrastructure platform, which is being led by the National Association of Pension Funds and the Pension Protection Fund, schemes’ investment in infrastructure remains relatively low.
You are only really now starting to see more asset managers come to the space and actually produce investable solutions
Public and private schemes hold just 1.2 per cent of their assets in infrastructure, according to figures from the NAPF’s 2012 annual survey and investment has stayed at similarly low levels.
Schemes moving into infrastructure debt investment with construction risk has taken longer than expected, but this is now starting to change, according to investment consultancy Redington.
Such investment typically includes schemes lending for an individual asset or project, such as the construction of a hospital or a school, or a bundle of smaller projects.
At a briefing on illiquid credit opportunities, Pete Drewienkiewicz, head of manager research at the consultancy, said some pension fund clients had been wary of construction risk in the past.
“It certainly seems that now we are seeing ways to mitigate that; a real move towards fixed-price contracts for construction firms with penalties for overrunning and penalties for extra costs,” he said.
There was also the possibility of banks writing a guarantee for such work if schemes did not feel fully at ease, added Drewienkiewicz.
The lack of fund options available to schemes could be one of the reasons for the slow growth of investment in the area.
“Irrespective of project availability, there weren’t really any viable asset manager opportunities [in the past]. You’re only really now starting to see more asset managers come to the space and actually produce investable solutions,” said Drewienkiewicz.
Attractive opportunity
Lending to operational infrastructure projects, such as the operating company of an airport or a port, is often considered the safer infrastructure financing option. This is because of the long-dated nature of the companies’ assets and the security of their underlying cash flows.
But loans to projects such as PPP and PFI could be attractive to schemes because ultimately the tenant will be a government entity, according to Andrew Wiggins, head of UK institutional at Allianz Global Investors.
“One of the barriers is the perception of construction risk in greenfield projects, but in reality for core PPP/PFI projects this is minimal and can be mitigated as well as being well-rewarded,” he said.
“There is a potential misconception equating infrastructure construction risk with commercial property development. The difference is that in a core PPP/PFI project you don’t put a spade in the ground until your tenant is signed up.”
The problem of schemes not having viable investment options has been eased by an increase in managers entering the market with their own assets behind them, Wiggins said.
“Infrastructure debt is a new opportunity for funds and it takes time for everyone involved to understand and get comfortable. That includes the borrowers, who are used to dealing with banks, as well as the lenders – ie, the pension funds – and the consultants,” he added.
While PPP and PFI projects offer benefits such as stability, there is the potential for such projects to go wrong, said David Cooper, investment director at infrastructure manager Industry Funds Management.
“If they do go wrong, it probably goes without saying that given the amount of debt and the relatively small amount of equity in these deals, it can get very painful for lenders,” he added.
