UK-based pension funds should increase their exposure to unlisted infrastructure closer in line with leading peers in Australia and Canada, given attractive asset characteristics and rapid global growth in the renewable energy sector in particular, showed a report produced by HSBC Global Asset Management and the Institute for Energy Economics and Financial Analysis (IEEFA), published on Wednesday.
Raising pension fund allocations to UK renewables can deliver stable returns for pension funds, while allowing developers to build projects at lower cost, and continued access capital at a time of investment uncertainty in the run-up to Brexit.
Notwithstanding opportunities in renewables, the report – written by myself and Helene Winch at HSBC Global Asset Management – found that UK-based pension funds presently allocate less than 2% of their assets under management (AuM) to unlisted infrastructure. And smaller, local government pension schemes collectively allocate just 0.6% of their £216 billion AuM to infrastructure. That compares with allocations of 5-15% by leading Australian and Canadian pension funds.
However, that may be about to change. An initiative to aggregate some 89 UK local government pension schemes (LGPS) into eight, multi-billion-pound “pools” is a particular opportunity to increase allocations to unlisted infrastructure including renewables, by giving these pools more clout to do deals.
Our report, “The renewable energy infrastructure investment opportunity for UK pension funds”, produced for the City of London Corporation’s Green Finance Initiative, described the rapid growth in renewables, as a result of rapid falls in generation costs and efforts to curb air pollution and climate change.
We showed that wind and solar power are expected to attract more investment than any other electricity generation sector for decades to come, while renewables in general are poised to overtake coal as the world’s main source of electricity by the mid-2020s.
Unlisted renewable energy assets can deliver stable, long-term, inflation-linked returns of 5-10%, given that they typically have long-term, quasi-government-backed, power purchase agreements. Such characteristics makes them ideally suited to pension funds seeking to match their long-dated liabilities over decades to come, as they pay out to scheme members.
Finding stable, long-term income streams is especially relevant in an era of record low interest rates, which have increased the present value of future liabilities. And even more relevant to defined benefit schemes, which still account for the vast majority of UK pension schemes by assets under management, at £1.8 trillion, given that these are now largely closed to new members and so are receiving declining contributions.
The report saw opportunities for pension funds to access renewables assets as a result of a growing trend for utilities to sell shares in large-scale wind projects. Europe’s biggest utility Enel has described this approach as a “build sell operate” model. Such an approach gives the pension fund part-ownership in a long-term asset, which the utility continues to operate, and allows the utility to refinance its construction costs and thus release capital to grow its construction pipeline.
The HSBC-IEEFA report estimated that existing UK large-scale wind and solar assets had a market value exceeding £40 billion, and unbuilt projects with planning permission had a value of more than £25 billion.
Reasons for low pension fund allocations to date include poor awareness of the recent growth in renewables, which now account for a quarter of UK power generation, for example, and the small size of some pension funds, which makes it more difficult for them to compete in infrastructure deals.
The UK government initiative to pool LGPS pension funds will help overcome these difficulties. Under that initiative, some 89 pension funds will be aggregated into eight pools, which go live in April 2018. Our report used public data to calculate that LGPS pools collectively would double their infrastructure allocation targets going forward, to 7.5% of AuM, from 3.7%, implying an additional £8 billion if these targets were met (see Table below).
There are already signs that the pooling initiative will lead to greater investments in renewables, with the Northern and LPP pools partnering via the specialised GLIL infrastructure fund to invest in UK onshore wind and waste-to-energy, for example.