UK pension funds are holding £1.5 trillion of capital – if they can be convinced to invest just 1% more into infrastructure assets, it could get £10 billion worth of stalled projects going. But, they are notorious for not investing in the development stage of projects, instead preferring to invest in operational projects.
Of course, you want your pension to be managed properly, but if you can build your pension pot with attractive guarantees from the government in case things go wrong; while enabling vital infrastructure to be provided in your community, and new jobs to be created – isn't that a smart solution.
The government's National Infrastructure Plan (NIP), published in 2011, identified a pipeline of over 500 infrastructure projects (gone up to 550 in the 2012 NIP update) valued at £310bn. According to the National Audit Office, 64% of the value of projects is likely to be wholly owned and funded by the private sector. Up until 2008, capital markets and banks were the main source for debt financing of infrastructure projects. But nowadays, getting hold of cheap and readily available long term debt is a thing of the past. So it's critical for the UK, that pension funds get with the programme, and instead of coming up with reasons not to invest, are proactive in finding solutions to perceived and real obstacles. That's just not what we do, is no longer an acceptable response.
Shovel-ready-projects aren't quite shovel ready
Despite the impressive spreadsheet Infrastructure Investment Pipeline of projects, published by HM Treasury in 2011 (and updated last year) there aren't many shovel ready projects around for trustees, advisers, analysts and fund managers to get excited about. Projects were put on hold, while the government worked through various sector and regulatory reforms. In the intervening period, construction output has fallen, key personnel have moved on, expertise has been lost, timescales have lapsed, and projects costs gone up. So it's all a bit theoretical at the mo. As Stephen Hammond MP hinted at, in his recent article on this site, one of the government's challenge is bringing projects forward quickly enough to give investors' confidence.
They prefer to shop in the Secondary market
In the context of project finance, primary investors put equity into the project at the outset. They bear the risk of bidding and construction, and so take a higher rate of return. Secondary investors buy the equity of already established projects, their returns aren't as high, but it's less risky, importantly they receive an immediate and stable income over a lengthy 25-30 years. It's easy to see why pension funds would prefer the secondary market. On the flipside though, the number of deals to be done in the secondary market is shrinking, so funds will need to broaden their investment horizons.
They don't like hairy a**e construction risk
Mention this thorny issue, and pension funds come out in puss-filled blisters. They have a deep aversion to taking on construction risk, especially for projects on Greenfield sites. This is understandable where small funds are concerned, because they don't have the in-house expertise to assess project risk or carry out due diligence like the banks do. So if it's a choice between investing in a low risk bond or a project with construction risk, they'll pick the bond. To deal with this, the government's new approach to public private partnerships, hints at giving guarantees against a range of project to risks; becoming a minority equity investor (around 30-49% of total equity requirement); and offering certain construction support packages to attract finance from institutional investors.
Project credit ratings don't make the grade
For pension funds, infrastructure projects need to achieve a credit rating in the A- to BBB+ to be investment worthy. A rating below BBB- is considered speculative or junk, and makes it a risky investment. Greenfield projects especially, have a lower credit rating and cost more to finance. To make infrastructure projects more attractive, investors are asking for "credit enhancement". In PF2, these enhancements look like lower gearing, so more equity around 20-25% (used to be 10% in old PFI) and the reassurance of having public sector co-investment in the project.
They are not big enough to bid
The £1.5tn of capital is held by over 7,500 different UK pension schemes. Individually, most funds just don't have the scale and money needed to directly invest in big infrastructure projects. The CBI's report on attracting investment to UK shows that 1,000 of these schemes have assets below £5m. To address this, The Treasury and National Association of Pension Funds have created a Pensions Infrastructure Platform (PIP). The platform will enable small pension funds to join up to invest in infrastructure projects, benefiting from pooled resources and expertise. The PIP aims to raise £2bn, it has the backing of the UK's major pension funds. But somewhat disappointingly, the platform will target projects free of construction risk.
They don't have the people
This has been mentioned a few times already, but only a few pension funds have the in-house expertise to structure, negotiate and make investments into infrastructure projects themselves. They don't want to hire a team of people, like the banks, to carry out the due diligence. If UK pension funds are to compete with their well-established North American counterparts then they'll need to build their own in-house resources.
They don't like government uncertainty
Investors are crying out for certainty and confidence, as the NAO mentioned in its report last month on planning for economic infrastructure: "Policy uncertainty. This could result in project sponsors, lenders and contractors deferring or abandoning UK projects in favour of opportunities elsewhere". The government published the Infrastructure Investment Pipeline, hoping greater visibility and information of projects, and their timescales, would give investors the ability to better plan. Another update due in Spring 2013. However, there's still a lot up in the air; the NIP Update 2012 mentions ploughing through reforms of planning regulations and energy markets; and ongoing industry reviews in nuclear, offshore wind, rail and road.