Pensions Suffer Due to Lack of Clarity Over Infrastructure

(December 5, 2011) — Pension funds in the UK may be at a severe disadvantage as a result of lack of clarity about infrastructure investing when it comes to understanding the risks associated with leverage, timing, and pricing, according to bfinance. 

UK Chancellor George Osborne’s call for pension funds to finance up to £20 billion in infrastructure projects may trigger renewed interest in this asset class from some of the UK’s largest pension schemes, the research firm continued to note. The National Association of Pension Funds (NAPF) and the Pension Protection Fund have signed up to discuss how they might become involved with the initiative of the government to invest more heavily in the asset class. 

According to research firm bfinance, many pension funds have experienced disappointing returns having been sold infrastructure as a bond substitute without understanding the risks associated with leverage, timing, and pricing. “Infrastructure is a broad term, encompassing many different types of assets and deal structures. It can be accessed through bonds, private debt or private equity. On the private equity side, if cash-flows are availability-based (and assuming the sovereign counterparty is sound) rather than user-pay, held for the long term and prudently leveraged, then one might argue its position as a bond substitute,” says Vikram Aggarwal, Director, Private Markets at bfinance. “However, in general, infrastructure funds often behave in the opposite way, by holding assets for relatively short time periods, using a lot of leverage which is often in the form of short term borrowings, leaving it vulnerable to re-financing issues and real risk of capital loss.”

“They are less exposed to sovereign risk as revenue streams are derived from millions of end users paying for essential services, rather than a limited numbers of public entities,” according to Mathias Burghardt, Head of Infrastructure Equity at AXA Private Equity, who sees infrastructure funds as a complement, rather than a substitute for bonds. “This means it is a natural fit with the long-term liabilities of many pension plans.”

On the announcement that the Government will unlock £20 billion from pension funds for infrastructure investment, Colin Robertson, global head of asset allocation at Aon Hewitt, recently told aiCIO in an emailed statement: “It is good to see the Government talking to pension funds about their requirements for investment. There is considerable demand from pension funds for infrastructure investments and this should be especially the case for Local Government schemes which can adopt a longer time horizon. However, pension funds must consider what is best for their scheme. They will need to take account of the illiquid nature of infrastructure and carefully assess the financial terms of the Government’s proposed investments.”

Another consultant reiterated the importance for pension funds to consider what is best for their scheme, noting that while the relationship between local governments and pension schemes can be a symbiotic one, with the benefit of infrastructure investing equally shared by both parties, the relationship often risks being plagued by misaligned interests. “Pension funds are, first and foremost, bound by their duties as fiduciaries and as such must seek the best possible investments, balancing expected returns with potential risks,” Timothy Barron, president and CEO of consulting firm Rogerscasey, told aiCIO. “Yet, for public plans particularly, there is a symbiotic relationship with their sponsoring entity, where a healthy sponsor is crucial to the long-term viability of the plan itself. Infrastructure investing may be an example where the plan fiduciary can provide capital to support the sponsor while benefiting the plan as well—this must be determined through careful due diligence of each individual opportunity, however, and is fraught with the potential for misaligned interests.”