With monetary policy reaching its limits, we expect to see a global shift to fiscal policy in coming years. Additional infrastructure spending is increasingly likely – economists suggest it contributes more to economic growth than other fiscal policies.
Chancellor Philip Hammond announced a new £23bn National Productivity Fund in November’s Autumn Statement, to be spent on innovation and infrastructure.
Action points
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Pension funds need a solution to mitigate volatility and outperform liabilities
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Government stimulus provides an opportunity for private investment in infrastructure
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Greater knowledge and availability of infrastructure programmes will encourage pension fund investment
In January 2017, commitments to infrastructure spending were reinforced in the government’s consultation paper ‘Building our Industrial Strategy’. Could this government investment restrain or crowd out private investment?
Greater knowledge of so-called ‘secure income’ assets means schemes are more accepting of lock-up periods and illiquidity
For UK pension funds, state actions are expected to act as a stimulus of private investment from pension funds. The government has stated its commitment to supporting private investment in infrastructure, with the chancellor launching a Treasury-led review into reducing the “barriers” to accessing “patient capital” from investors such as pension funds.
At a time when pension funds increasingly need additional yield from alternative investment sources such as infrastructure, this is to be welcomed.
An attractive asset class for pension funds
With the fall in government bond yields seen over the last few years, UK pension fund deficits have increased to unprecedented levels. Low bond yields are unlikely to be a temporary phenomenon.
Structural factors – ageing populations, weak productivity and excess savings – will limit growth and cap future interest rate rises.
Our capital market assumptions show subdued returns across all asset classes, including particularly poor five-year returns on government bonds – the default asset for pension funds to meet their long-term liability cash flows.
Trustees are faced with seemingly conflicting objectives: to reduce funding level volatility (suggesting reducing asset risk), but outperform liabilities to claw back these deficits (suggesting increasing asset risk).
Assets such as infrastructure debt or equity are crucial to solving this puzzle. They provide long-term cash flows to better match promised benefit obligations, but also offer higher yield levels than those available through investing in public debt.
Investing in infrastructure is not a new theme for UK pension funds. Following the credit crisis, opportunities opened up in private markets as banks reduced their lending in light of regulatory changes.
However, despite pension funds’ need for higher-yielding assets, investment to date in infrastructure projects by UK pension funds has been limited.
In 2012 the Pensions Infrastructure Platform, a subsidiary of the Pensions and Lifetime Savings Association, was launched, with a target of £2bn. To date the platform, according to the PiP, has attracted around £1bn.
What is holding pension funds back?
The challenge is finding suitable projects for pension fund investors; construction risk and complex fee structures continue to deter UK pension funds that want low-risk investments with immediate availability of returns.
The UK government’s 2017 industrial strategy paper suggests a willingness to consider construction-only guarantees to encourage private sector investment.
This would help – to date, pension funds have preferred to refinance already operating projects, or have needed reassurance against construction risk. An example is London’s ‘super sewer’, which saw investors require government guarantees and an initial investment return.
Infrastructure projects: The potential and the risks
Infrastructure development could spur Europe’s economies into growth. Yet austerity measures have led to a lack of investment. The UK’s infrastructure investment deficit alone stands at £60bn.
However, attitudes are changing. Greater knowledge of so-called ‘secure income’ assets means schemes are more accepting of lock-up periods and the illiquidity that accompanies investments such as infrastructure, and greater product availability makes these assets more accessible to smaller schemes.
A clear development mandate from the government, taking into account where private capital is already active, can mitigate the risk of crowding out private investors.
Pension fund investment in infrastructure would be mutually beneficial for the government and the pension fund industry – it is in everyone’s interests for this patient capital to be put to work.
Vivek Paul is director of client solutions at BlackRock
This article was changed since original publication to more accurately reflect figures relating to the Pensions Infrastructure Platform
