A tough sell

If you are a regular reader of Infrastructure Investor’s daily news website (and if not, why not?) 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 these pensions. But their increasingly steady nature is a great sign for GPs: it means UK pension appetite for infrastructure is steadily 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 UK infrastructure – to the tune of £20 billion, to be precise. But unfortunately for the government, that’s where the good news ends.

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 infrastructure programme.

One glaring example: the UK infrastructure 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 patriotic 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 is effectively putting all your 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 UK infrastructure? “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 dish out at Labour’s much-used Private Finance Initiative (PFI). PFI is the UK’s standardised procurement process for public-private partnerships.

After all, most of the criticism lobbed at PFI – higher cost of capital compared to 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 capturing pensions’ attention.

The off-balance sheet angle, especially, can be easily exploited for political fireworks.

In a recent Treasury Select Committee report, the MP group expressed concern that PFI will continue to be used mainly because of the off-balance sheet benefits it offers rather than for genuine value-for-money concerns. Considering the government does not want to increase public borrowing, the committee concluded that the off-balance sheet incentive offered by private infrastructure financing is not likely to go away anytime soon.

Chancellor George Osborne, by including PFI liabilities in last July’s first unaudited Whole of Government Accounts (WGA), has also opened himself up to the question of why, exactly, should the UK use more expensive private finance to build its infrastructure? Is the answer because the government is not yet ready to follow through on the WGA’s premise and implement changes to how it accounts for its liabilities?

At the end of the day, pensions have fiduciary obligations to their trustees and will not start piling 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 ambitions.