“How infrastructure is winning its place in pension fund portfolios”. This was the title of a recent breakfast presentation delivered by First State Investments at the international fund manager’s London office.
The title has the advantage of being attention-grabbing and upbeat. To have lumbered the presentation with a less catchy and more qualified title such as “How infrastructure is just starting to win its place in pension fund portfolios but has a very long way to go” would not have captivated the assembled press throng to the same degree. But the latter might, at this point, tell the story a little better.
Russell Investments’ 2010 Global Survey on Alternative Investing revealed that, in 2009, institutional investors, including pensions, were committing 86 percent of their alternative investment allocations to a mixture of hedge funds, real estate and private equity. Infrastructure accounted for a mere 2 percent of the alternative assets allocation.
First State is absolutely right to point out that attitudes are changing. As part of the same survey, the institutions canvassed said they planned to increase their infrastructure allocation to 6 percent of the alternatives total by 2012. Over the same period, by contrast, they planned to reduce their exposures to hedge funds and real estate. The trend is, therefore, infrastructure’s friend. But it’s undeniably coming from a very low base.
Danny Latham, First State’s European head of infrastructure investment, jokingly suggested at the breakfast that, if judged purely on the desirability of its investment characteristics, infrastructure might warrant a 100 percent allocation. With pensions seeking less volatility, inflation protection and greater diversification – infrastructure ticks the boxes.
The trouble is, investing in infrastructure requires a leap of faith because of its immaturity as an asset class. This was underlined when the presentation referenced data comparing returns delivered by a range of asset classes in the UK. Tellingly, the “UK” unlisted infrastructure returns actually comprised data borrowed from the Australian market to act as a proxy since meaningful UK data apparently does not yet exist.
Based on this proxy, the data in question shows that unlisted infrastructure would have preserved capital through the financial crisis better than all the other asset classes except fixed income. And that’s why some pioneering pensions, particularly in Scandinavia and the Netherlands, are prepared to take a gamble (both on the scant track record of individual fund managers, as well as that of the asset class overall). It’s interesting to note that in the UK, where consultants have a more influential role in pension portfolio construction than elsewhere in Europe, infrastructure allocations tend to be lower. Here, track record is prized.
Of course, the attitude of the more conservative pensions is understandable. Proponents of infrastructure as an asset class may talk a good game, but all that talk is no substitute for cold, hard evidence of solid long-term performance. Many pensions may well continue to feel that they don’t need the magic ingredient of infrastructure to lower risk and volatility in their portfolios – their present heavy reliance on long-dated bonds performs that function very nicely.
But will it continue to do so in the future?
In an exchange with Infrastructure Investor that followed the presentation, Gary Withers, First State’s regional managing director for EMEA, offered this view: “Following the global credit crisis and subsequent quantitative easing, bond markets have been regarded as heavily over-priced by many market commentators, given the potential for inflationary forces to emerge. There are those who believe that long-dated bonds might still deliver positive returns, but it would be a mistake to see this as a low-risk investment strategy at this juncture.”
The danger of forming the kinds of assumptions referred to by Withers makes this a challenging time for investors – one in which, more than ever, past precedent may not necessarily be a useful guide to the future.
For infrastructure GPs on the fundraising trail, minus a long track record but convinced of their merits, this is the basis of the argument they need to make in order to win their place in portfolios sooner rather than later.