Around the fringes of our recent Berlin Summit, talk turned on more than one occasion to prospects for listed infrastructure in Europe. A number of delegates believed that this was a market on the cusp of exciting growth.
To date, Europe has not really embraced listed infrastructure. While there is a small universe of listed funds (many of them doing rather well), they find it difficult to attract attention from institutional investors such as pension funds and insurance companies. But there are reasons why this may change.
After all, investors in infrastructure are finding it increasingly difficult to deploy capital in a sensible way given concerns over the level of competition for deals and the resultant increase in pricing. This is coupled with a sense that unlisted funds all too frequently fail to offer sufficient alignment of interest when it comes to terms and conditions.
This is prompting investors to scrutinise the possible merits of listed funds a little more closely. It could lead them to discover afresh – or be reminded of – the ability to deploy capital quickly, at relatively inexpensive pricing levels, and achieve a degree of diversification that is typically harder to achieve through unlisted funds.
On the other hand, they may be deterred by the short-term volatility of listed infrastructure and its correlation with their existing equities exposure. Despite the ingenuity being applied to the structuring of listed products – which aims in various ways to provide maximum comfort for investors – some may find these factors too much of a challenge to overcome.
Traditionally, the issue of market volatility has been of particular concern. In Australia, where listed infrastructure has achieved an unrivalled level of maturity, pension schemes are typically defined contribution (where only contributions are guaranteed, not future pay-outs). This means such schemes are sanguine with regard to short-term market fluctuations in the expectation that performance will reach expected levels in the long run.
By contrast, the defined benefit scheme (where the pay-out is guaranteed) has dominated in Europe, especially in the UK. And, for these schemes, a sudden market fall can have catastrophic impacts on the value of pensions being paid out then.
However, an existing trend for employers to consider switching from defined benefit to defined contribution schemes – due to the higher cost of the former – has been exacerbated by the continuing low interest rate environment (higher interest rates having previously helped cover promised benefits). Therefore, it appears probable that Europe will follow Australia in its embrace of the defined contribution scheme.
This helps to explain the conversations about listed infrastructure that are now taking place. While it's too early to call a significant shift in investor allocations, there is at least a feeling that sentiment may be changing – and that this may be a precursor to something more substantial happening down the line.