A tough sell

UK pension appetite for infrastructure as an asset class is steadily increasing. That’s great news for fund managers, but not necessarily good news for George Osborne’s ‘Pension Finance Initiative’

If you are a regular reader of Infrastructure Investor’s daily news (www.infrastructureinvestor.com) you might have noticed a recent stream of announcements from general partners (GPs) signalling they have been awarded debut infrastructure mandates from local UK pension funds.

These cheques – from the likes of the Northumberland and Shropshire pension funds – are usually in the £20 million (€24 million; $31 million) to £35 million range – mirroring the small to medium size of the institutions writing them. But their increasingly steady nature is a great sign for GPs: it means UK pension appetite for infrastructure is growing and a new source of capital is opening up.

At first glance, this should also be positive for the UK Treasury’s much-vaunted plan to get UK pensions to help fund the country’s infrastructure – to the tune of £20 billion, according to the authorities. But unfortunately for the government, things may not be that straightforward.

Because as soon as you start talking with many of these pension funds, you quickly discover that much of what they like about infrastructure is unlikely to be offered by the government’s programme. 

One glaring example: the programme is unable to provide geographic diversification. Many in the coalition government have expressed astonishment at the fact that foreign pension funds will make significant investments in UK infrastructure whereas UK pensions will not. 

But while ‘British pensions for British infrastructure’ might tug the heartstrings in certain quarters, it misses a fundamental point: for foreign investors, substantial investments in the UK are usually part of a diversified investment strategy. For UK pensions just getting started in the space, investing massively in UK infrastructure would mean putting all their eggs in one basket. 

As one local pension source put it: “We do feel that investing in infrastructure has to be a global play and the UK proposal rules that out. Maybe it’ll be interesting for overseas pensions, but I believe it’ll be incredibly difficult for the government to raise £20 billion from UK pension funds.”

So what will it take to get UK pensions to fund significant amounts of infrastructure in their home market? “It will depend on the terms offered by government,” said another pension manager – i.e., what returns its upcoming pension framework will be able to provide and whether they are secure and attractive enough to merit attention.

The problem is, once government starts discussing minimum returns, it will open itself up to the sort of political mud-slinging it has been more than happy to direct at Labour’s much-used Project Finance Initiative (PFI). 

After all, most of the criticism lobbed at PFI – higher cost of capital compared with gilts, contractual rigidity and dubious off-balance sheet incentives – will most likely be valid for the new ‘Pension Finance Initiative’ – if it is to have a real chance of luring pensions. 

At the end of the day, pensions have fiduciary obligations to their trustees and will not pile into infrastructure just because governments want them to. 

“Governments tend to think short term; we need to think long term,” one of the pension managers said. Pricing that long-term adequately will be the key to the success – or failure – of the UK government’s pension-related ambitions.