IEEFA update: U.K. pension funds lag in renewable energy infrastructure investing

LONDON — Local U.K. government pension schemes are gradually increasing their unlisted infrastructure holdings, driven by examples set by 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 single segment of infrastructure investment in the world (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 just this week that activity “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.”

The U.K. has 89 local government pension schemes (LGPS), which allocate far less of their total £263 billion (US$342 billion) of assets under management (AuM) to infrastructure than leading pension funds do, mostly notably funds in Australia and Canada.

Collectively, these British LGPS funds had allocated just 0.75% of their total assets to infrastructure, as of March 31, 2017, according to the latest available data. That compares with leading pension schemes such as Canada’s OMERS, which has 14% allocation to unlisted infrastructure; Australia’s HESTA (9.2%) AustralianSuper (9.1%); and Canada’s Ontario Teachers’ Pension Plan (8.3%).

Infrastructure allocations are increasing nonetheless, driven by programs that include a new U.K. government initiative to pool the assets and investment activities of all 89 LGPS funds.

The program stems from policies that see an increase in the scale of individual investment management capabilities as key to effectively deploying capital into more complex, illiquid assets—especially infrastructure, given that LGPS fund historically have lacked scale and specialist infrastructure teams to support such investing.

Eight investment pools have been created as a result of the initiative, most of which exceed the government’s desired minimum size of £25 billion assets under management (AuM).

SECTOR LEADERS, BY SHEER FORCE OF EXAMPLE, ARE ALSO DRIVING local pension government schemes to invest more in infrastructure. At a handful of LGPS funds, returns on infrastructure outperformed equities last year. Among the examples: Northumberland County Council Pension Fund (28.4% returns on infrastructure in 2016/17) and the London Borough of Hillingdon Pension Fund (23.1%). Some LGPS funds now have relatively high allocations to infrastructure, led by the Lancashire County Pension Fund (13% of AuM), the Barking and Dagenham Pension Fund and Croydon Pension Fund (both 8%), and the Brent Pension Fund(7%).

Recognising the opportunity for long-term, stable cash flows, some funds are moving capital into infrastructure assets as a strategy to consolidate 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 state that they now intend either to expand their allocations to infrastructure or establish infrastructure investment mandates for the first time.

For example, the London Borough of Barnet Pension Fund has established a 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 those in 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.

Understanding “deal flow,” meaning the availability of attractive opportunities, is key, as was highlighted in a June workshop led by IEEFA and the City of London Corporation that convened potential investors, including pension fund and specialist asset managers.

ASSET MANAGERS REPORTED PROFITABLE PRIMARY MARKETS IN COUNTRIES INCLUDING FRANCE, where new renewables targets introduced by the Macron administration are driving growth, and large secondary markets elsewhere, including the U.K., with its estimated £70-80 billion market.

The workshop acknowledged concerns about a gradual reductions of subsidies for such markets, but asset managers concluded growth will continue regardless, driven by innovation that will include trends toward combining wind and solar with battery storage, and by prospective new demand from long-term power purchase agreements with companies and local governments that would fill any gap left by reductions in central government support. In addition, more 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 continue to underpin growth.

As the IEA stated this week: “Investment in all forms of clean power, as well as in networks, would need to rise substantially under a sustainable development scenario.”

U.K. 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.

Gerard Wynn is a London-based energy finance consultant.

[Report on IEEFA/City of London June 19 proceedings: “The Renewable Energy Infrastructure Investment Opportunity for U.K. Pension Funds” and related PowerPoints Liontrust, Greencoat Capital, Impax Capital Management, and Aquila Capital.]

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