Long-term infrastructure investments lie at the heart of Westminster’s latest plan to boost the nation’s economy. In the foreword to the government’s Build Back Better policy document, Boris Johnson writes: “We will redress Britain’s historic underinvestment in infrastructure, with £600bn of gross public-sector investment over the next five years, so our United Kingdom becomes a truly connected kingdom.”
Infrastructure projects aren’t simply about building roads, bridges, ports and airports. They also deliver public institutions such as schools and hospitals. Social housing is also being targeted for investment. This is one of the main reasons why the government has been engaging with other big investors, such as pension funds, insurance companies and local authorities.
Investment is all about risk and reward. The bigger the risk you take, the more you should expect to receive in return. Infrastructure investments tend to tie up capital for longer periods. The so-called illiquidity premium they pay to compensate for this is what makes them attractive to investors.
Pension managers, insurers and sovereign wealth funds – for instance, the Saudi Arabian Public Investment Fund that recently bought Newcastle United Football Club – all take a long view when it comes to investment. Bonds – usually government-issued gilts – are a key component of their highly diversified portfolios, as these provide a relatively reliable income over the medium to long term with little risk. But the exceedingly low interest rates since the global financial crisis of 2007-08 have depressed bond yields, prompting investors to seek comparable returns elsewhere. This in turn is leading to increased allocations to asset classes offering a comparable balance of risk and return.
Many institutional investors have historically considered infrastructure projects too risky for the effort these tend to require. Their argument has been that you need specialist advice and the ability to negotiate the right price on the way in, or you’ll never achieve the returns you’re seeking. By contrast, they have seen real estate as a stalwart option for decades. Yet neither of those characterisations is accurate. The two sectors have experienced very different fortunes in recent years.
The financial crisis exposed some structural problems with property that have only become clearer since then. In commercial real estate, demand for high-street retail space has fallen as we do more of our shopping online. Anything but premium office space in the big city centres has been on the slide for years. There simply isn’t the demand for secondary (on back streets) and tertiary (on ring roads) space that there once was. Some of these properties have been converted into housing in recent years. If they are near good transport links, they’re likely to become prime development sites for local authorities with affordable-housing quotas to fill.
This shows that, however much we might think real estate is as safe as houses, certain parts of the market aren’t necessarily a sound long-term punt. What’s more, there are newer risks to consider. For instance, achieving the UK’s goal of carbon neutrality by 2050 has fast become the main environmental, social and governance (ESG) commitment of businesses and their investors.
A recent report by Carbon Intelligence identifies the risk posed by the real-estate sector to investors’ net-zero aspirations. While any property under construction today should meet environmental specifications, about three-quarters of the buildings that are likely to be in use in 2050 have already been built.
“When investors start lifting the lid on their portfolios, they’re probably going to see that they’re reliant on outdated technology and ways of operating buildings,” says Chris Parrott, an independent pension trustee and former head of pensions and benefits at Heathrow Airport. That leaves this ‘safe’ asset class with considerable exposure to climate-change risk, creating a lot of work to align the sector with ESG targets. The costs involved will reduce investors’ returns.
Infrastructure, so long associated with crucial – but not necessarily ESG-friendly – objectives, has had something of a rebirth as more and more nations chase net-zero targets. As a sector, it’s responsible for the many renewable-energy projects that are proliferating around the world. Nonetheless, these all still carry ESG risks. For instance, any investment in battery storage would rely on cobalt mining. Most of the world’s cobalt is produced in the Democratic Republic of the Congo, a nation with one of the most consistently poor records for human rights abuses.
Such infrastructure projects are unlikely to interest pension fund managers. Given that they have fiduciary duties to their members and must also meet the expectations of regulators and society at large to invest responsibly, they are cautious by nature.
Sally Bridgeland is chair of the Local Pensions Partnership Investment, which manages the investments of some of the largest council pension schemes. She says that “the important thing is to look at things that other people are not invested in, in both property and infrastructure. The risks associated with infrastructure differ from those involved in real estate. You need to understand these risks and, ideally, have the skills to manage them internally.”
One growth market that straddles real estate and infrastructure is the development of sustainable cities that include social and affordable housing. These are termed ‘impact investments’, as they can be seen to have positive benefits on local communities.
The number of social housing units in the UK has plummeted from its peak of 6.6 million in the late 1970s to about 2 million. Parrott thinks that the effort to rebuild the nation’s social housing stock could be a “game-changer” for council pension funds.
These funds can’t simply finance house-building for the local authorities they’re associated with, as that would breach their fiduciary duties. But there are ways in which they can invest in asset classes that match their principles, according to Karen Shackleton, an independent investment adviser to public-sector pension funds.
“While climate change has been a primary focus for many investors, local government funds have identified sustainable cities as something they’re interested in. This is because they satisfy both the environmental and social aspects of their ESG criteria,” she says. “Social and affordable housing projects are very much an impact strategy, because these can achieve councils’ goals in helping the homeless and other vulnerable people.”