UK pension funds urged to step up infrastructure investing to boost long-term economic sustainability

infrastructure energy

Pension funds in the UK are being urged to step up their infrastructure investment, as speakers at a pensions conference this week emphasised the need to preserve the long-term sustainability of the UK economy.

A recent report by PwC found that the UK will need to increase infrastructure spending to GBP40 billion a year, double the current level, in order to reach its target of net zero by 2050.

“In the UK, investment in infrastructure by long-term investors is minuscule,” said Nick Silver, co-founder of the Climate Bonds Initiative, at the World Pensions Council event.

Pension funds allocate on a risk-return basis, and have historically shown a strong preference for liquidity – leading many to invest in highly liquid government bonds rather than more illiquid infrastructure projects.

Silver said that many of these investments are “not suitable” given the real time horizon of many pension funds. 

“Even if the pension is large, it's still a relatively small fraction of the overall size of the liabilities,” he said. “Most of it is effectively funded by contributors and future contributors, and the actual valuation has a 75-year time horizon.” 

Pension funds should invest in the long-term sustainability of the economy in order to preserve these future contributions, said Silver.

“The pension system as a whole has to invest in a way that in the long term will pay back its pension. For the regulator and for the government, the purpose of the pension system is to ensure that the assets are managed to generate long-term sustainable returns.”

Pension funds’ allocations are starting to change, with UK local government pension schemes slashing their investment in hedge funds and shifting nearly GBP1 billion into infrastructure projects last year alone. 

In November this year, a group of local government pension schemes also announced they would be pooling GBP840 million to invest in infrastructure projects through the Brunel Pension Partnership.

A recent survey by Aviva Investors showed that over a third of pension funds expect to increase their allocation to real assets such as infrastructure even more over the next year.

Silver pointed to infrastructure as an asset class, and the rising allocations in Australia’s superannuation pension system, which has grown six times in size over the last 25 years, to overall assets of AUD3 trillion.

Former CEO of IFM, the largest infrastructure investor in Australia, Brett Himbury said at the same event: “Frankly, I think [infrastructure as an asset class] is just so underweight.”

“When I look at pension funds around the world outside of Australia, which is a bit of an anomaly, generally they have their highest allocation to fixed income. A very small allocation of that fixed income may be sub-allocated to infrastructure debt.”

Environmental upside and higher returns have often gone hand in hand with infrastructure investments. Himbury gave the example of IFM’s investment in Melbourne Airport, through which it ensured that 25 per cent of the airport’s power could reliably come from solar panels. “What does it do? It reduces the carbon emissions, terrific… But what else did it do? It reduced our power bill.”

“Infrastructure at its very core is more than an asset class. It is a service that provides a vital community need,” said Himbury. 

One of the difficulties of ESG investing for pension funds is the heated debate over whether investing for a positive impact, rather than purely for financial return, breaches their fiduciary duties.

Regulation differs across the world, as the EU’s green taxonomy has encouraged pension funds to invest sustainably, while the US Department of Labor has mandated that pension schemes must not incorporate environmental, social and governance (ESG) considerations into their asset allocation decisions at the expense of financial returns.

Silver concluded that a shift is needed in UK pension funds’ investments: “Risk and return is important, but it's not the main characteristic. It shouldn't be ‘risk-return, plus a bit of ESG’, it should be effectively, ‘We need the economy to grow in a long-term sustainable way’. That sounds quite a lot like ‘ESG, and the risk-return would be nice’.”