UK infrastructure too narrow for Leicestershire

The UK lacks diversification for a specialised infrastructure investment, according to the Leicestershire County Council Pension Fund.

The £2.25bn scheme made its first investments into infrastructure at the beginning of the year, with allocations of £35m into two global funds.

The move comes against a backdrop of the UK Treasury trying to woo pension schemes to invest in UK infrastructure projects, with £200bn worth of developments planned over the next five years.

But Colin Pratt, investment manager at Leicester County Council Pension Fund, said: “We would probably have had slight reservations about investing solely in the UK as it is a relatively small geographic area.

“We feel diversification by geography and industry are important.”

Pension schemes are increasingly attracted to infrastructure investment as it provides long-term, inflation-linked returns. These help schemes manage the risk of inflation-swelling deficits.

But schemes have been put off investing in infrastructure funds due to the high levels of leverage often involved and poor past performance of some funds.

Leicestershire’s reasons for entry

The Leicestershire scheme had traditionally relied on UK index-linked bonds to achieve inflation-matching but felt they were not currently an attractive investment.

“We decided to look at our investments on a much more holistic basis,” said Pratt.

We do not have a preference for greenfield or brownfield. We appoint managers with expertise in both

“We then decided to invest in infrastructure and timber, as well as some global index-linked bonds.”

The draw of these asset classes was their cash flows being linked to inflation. They also offered attractive returns compared with UK bonds.

The first manager Leicestershire chose was Industry Funds Management, which has an open fund with a cash-plus-10% benchmark.

The second was KKR, which has a closed, more traditional fund based on a private equity model.

IFM’s open fund, which is unusual in the infrastructure space, allows schemes to invest more quickly and is designed to hold assets over long periods of time.

The closed funds like KKR are more focused on making short-term returns, with a high turnover of assets in the portfolio.

Pratt said the two managers’ different approaches complemented each other.

One of the main reservations UK schemes have about taking up the Treasury’s offer to invest in UK infrastructure is how the deals are structured.

The Treasury is pushing greenfield projects such as new roads and train lines. But these come with significant construction risks that schemes are reluctant to take on.

They are much more interested in brownfield projects. These are assets that have already been built and do not come with construction risks.

But Pratt added: “We do not have a preference for greenfield or brownfield. We appoint managers with expertise in both.”

Problems with UK infrastructure

John Hastings, partner in Hymans Robertson’s investment practice, advised Leicestershire on its infrastructure investment.

He has been working with a number of local authority schemes considering the asset class.

We would not be able to see the diversification if we just invested in UK projects

“What they are looking for is diversification across the asset class, with a global perspective,” he said.

“It’s hard to see quite where in the UK a supply of funds is going to come from.”

Infrastructure assets that are most attractive to fund managers are those with monopolistic characteristics.

But many of these assets – such as utilities companies – have already been sold off by the UK government in earlier waves of privatisation.

Prime minister David Cameron’s recent announcement of promoting toll roads to pension scheme investors was a rare example of available infrastructure assets with monopolistic characteristics.

Christian Seymour, head of European infrastructure at IFM, said geographic diversity was also a key characteristic he looked for in an asset.

“We would not be able to see the diversification if we just invested in UK projects,” he said.

There is a level of systemic regulatory risk in only investing in the UK as all projects will be subject to the same legislation."

Pratt added: “You can understand why some are attracted to investing in the UK because it is the home market and there is a comfort factor. But time will tell if it works out.”