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UK local government pension schemes are gradually increasing their unlisted infrastructure holdings, driven by the example of trail-blazing funds and by a new government initiative to increase the scale of such investments.
But few are investing explicitly in renewable energy, the biggest segment in unlisted infrastructure investment worldwide.
Infrastructure investing involves real assets such as roads, railways and power plants. The International Energy Agency (IEA) has repeatedly raised the alarm over slowing investment trends in global energy infrastructure, reporting last week that this “remains insufficient for meeting energy security, climate and air quality goals, and is not spurring an acceleration in technologies needed for the clean energy transition.”
Britain has 89 local government pension schemes (LGPS), in England and Wales, which allocate far less of their total £263 billion (US$342 billion) of assets under management (AuM) to infrastructure than much larger, leading pension funds, such as in Australia and Canada.
Collectively, the UK LGPS funds allocated just 0.75% of their total assets to infrastructure, as of March 31, 2017, the latest available data. That compares with Canada’s OMERS, which allocates 14% of its AuM to unlisted infrastructure; Australia’s HESTA (9.2%) AustralianSuper (9.1%); and Canada’s Ontario Teachers’ Pension Plan (8.3%).
A new UK government initiative is seeking to boost LGPS allocations by increasing the sale of their investment activities, aggregating the management of the 89 funds into eight pools. Local government pension funds historically have lacked the scale and specialist infrastructure teams to support infrastructure investing. The eight new investment pools mostly exceed the government’s desired minimum size of £25 billion AuM each.
Besides this government initiative, some LGPS pension funds are already leading by example, with relatively high allocations to infrastructure, led by the Lancashire County Pension Fund (13% of AuM), Waltham Forest (10%), the Barking and Dagenham Pension Fund and Croydon Pension Fund (both 8%), and the Brent Pension Fund(7%).
Others are showing healthy returns to infrastructure, in some cases outperforming equities last year, for example at Northumberland County Council Pension Fund (infrastructure returns of 28% in 2016/17), and the London Borough of Hillingdon Pension Fund (23%).
Another driver for higher infrastructure allocations is the recognition that the resulting long-term, stable cash flows, can form a strategy for consolidating recent gains from rising equity markets.
This approach is summarised in the latest annual report from Newham Pension Fund:
“The Committee’s priority is now holding onto those gains, given that the values of equities and bonds are at historically high levels and the outlook is increasingly uncertain. The strategic direction is now firmly set toward alternative assets: property, infrastructure and fixed income assets that are less exposed to the headwinds affecting volatile equity markets while employing proven techniques to manage volatility on the remaining equity allocation.”
Several LGPS schemes now intend either to expand existing allocations to infrastructure, or establish new infrastructure mandates for the first time. For example, the London Borough of Barnet Pension Fund has established a 5% mandate, implying a long-run target to allocate 5% of its assets to infrastructure, appointing IFM Global Infrastructure Fund. Powys Pension Fund in Wales has established a 10% mandate. Funds expanding their infrastructure mandates in 2016/17 included the London borough of Bexley, to 8% from 3%, and in Derbyshire, to 5% from 3%.
Still, LGPS funds have been slow to appreciate the opportunity in renewable energy infrastructure investing, even though it is the largest infrastructure investment market globally, according to the specialist data provider, Preqin.
Concerns around “deal flow,” meaning the availability of attractive opportunities, is one possible barrier, as highlighted in a workshop led by IEEFA and the City of London Corporation, which last June convened potential investors, including pension fund and specialist asset managers.
At the workshop, asset managers reported profitable primary markets in France, especially, where new renewables targets introduced by the Macron administration are driving growth, and large secondary markets elsewhere, including the UK, with an estimated £70-80 billion market in unlisted renewables infrastructure, where investors have found attractive risk-adjusted returns.
The workshop acknowledged concerns about a gradual reductions of renewable energy subsidies, but asset managers concluded growth would continue, driven by innovation, for example to combine wind and solar with battery storage, and by prospective new demand from long-term power purchase agreements with companies and local governments, to fill a gap left by reductions in central government support. In addition, electrification of transport, heating and industry is expected to drive new demand for electricity, while ambitious climate action targets across Europe and further afield will underpin renewables growth.
As the IEA stated last week: “Investment in all forms of clean power, as well as in networks, would need to rise substantially under a sustainable development scenario.” UK local government pension schemes can take greater advantage of this opportunity by capitalising now on an increasing awareness of the challenges of climate change and the energy transition underway.
More details on the IEEFA/City of London Corporation workshop can be found here: