Rattling the foundations
Written by Marek Handzel
Marek Handzel explores whether the IORP Directive may shake pension funds’ increasing investment in infrastructure
Economic forecasters are expecting an infrastructure-spending whirlwind to swirl its way across the globe over the next decade.
One investment manager, Robeco, has predicted that worldwide infrastructure spending will double as a percentage of global GDP over the next 10 years. It is confident that emerging economies will continue to spend to maintain urban growth and economic demand, while developed countries will have to start replacing their aging and energy-inefficient infrastructure base at the same time.
“At currently expected nominal world growth rates of about 7 per cent for that period, this implies an average nominal growth rate in infrastructure spending of 10-15 per cent,” says Robeco infrastructure equities manager Steef Bergakker.
But a large injection of money is needed at a time when governments and banks are undergoing one of the largest deleveraging exercises in history. Which is why, of course, pension funds are stepping into the middle of the vortex.
“There is an obvious pairing with infrastructure and pension schemes as a source of capital,” says Mercer senior infrastructure consultant Tony Buscombe.
The consultancy released a survey earlier this year that showed allocation to infrastructure and alter-native asset classes has increased year-on-year in Europe since 2003.
However, the increases have not been large. In Europe (ex-UK), only 3.9 per cent of all funds have an allocation to infrastructure. Higher up the scale the picture is different. For schemes that hold over €2.5bn in assets, 26.3 per cent of them have some exposure to the asset class.
“Pension funds are crying out for assets that provide linkage to inflation,” says Buscombe.
“They also want stability and predictability in underlying returns and a degree of respite from volatility, as well as something different from the anaemic returns they have received from traditional assets.”
Natixis Global Asset Management re-affirms this trend. It has seen clear signs that infrastructure investment is gaining momentum among pension funds - and not just on the larger scale. It has observed move-ment among smaller funds who are amenable to being involved in infra-structure funds with other investors.
Into the eye of the storm
Nevertheless, some pension schemes remain wary of walking into the eye of the storm.
Firstly, hang-ups remain following the onset of the financial crisis. The experience of investors in the run-up to the collapse of Lehmans still rankles.
At the time, investors and managers took more risk, with aggressive gearing and questionable investments, resulting in rather mixed sets of returns, damaging infrastructure’s reputation as a steady and safe asset class after more than a decade’s worth of good results.
Secondly, points out Buscombe, it is a relatively new asset class and there is still a lack of understanding across typical institutional investors in Europe, apart from some Dutch and Scandinavian trustees.
Thirdly, infrastructure is one of the most illiquid of investments. If a sponsor is looking to get a defined benefit scheme transferred off its books, for example, then it may wish to have a more dynamic portfolio to play with.
Not everyone accepts that illiquidity is as much of a problem as some make it out to be, however.
“A lot of time people exaggerate words such as illiquid,” says EISER Infrastructure head of asset management Wael Elkhouly.
“Clearly it is (illiquid). Infrastructure funds tend to be on average a longer-term investment and that involves some constraints. But as part of a portfolio that is well managed then it plays an important role.
“That is one of the reasons that some of the bigger funds are looking to invest directly. Funds don’t want their money given back to them quickly. They want to keep it in there for some time. So the liquidity issue is often over-played,” he adds.
Natixis also plays down worries about liquidity, using the UK’s recent Kay review’s focus on long-term returns and pension funds’ renewed appetite for real assets, as evidence of trustees looking to further their investment in infrastructure.
Governments across Europe have sensed this too, and have been vocal in encouraging pension funds to come forward to help build new roads, railways and buildings.
The problem with this however, is that politicians want to see money flowing into new developments, whereas pension funds tend to err on the side of caution and invest in brownfield sites.
“Governments are trying to get schemes into the greenfield area,” says Elkhouly. “That causes issues.
“So far most financial investors have shied away from assuming structured risk. So governments are addressing the issue of how to invest in infrastructure of that nature and finding ways to channel that capital,” he says.
Cooling the atmosphere?
But ironing out the detail on greenfield sites could be the least of everyone’s worries. Fears have been raised in the UK, Germany and the Netherlands, that The European Commission’s (EC) Directive on Institutions for Occupational Retirement Provision (IORP) could dampen allocation into long-term building and development projects.
“It’s rather ironic that in a world where governments are trying to overcome broader funding constraints, that this is on the horizon,” says Buscombe.
“In a practical sense it is another challenge for trustees to overcome in their minds and another reason for some people to not consider the asset class.”
Speaking in Amsterdam on 1 June, the European Commission member responsible for Internal Market and Services, Michel Barnier, looked to reassure pension funds over the capital requirements that may be imposed on them, stressing that nothing had been decided as yet.
Telling his audience that the EC was waiting to see the results of quantitative impact assessments of the directive, he confirmed that it would not be until 2013 that the revised directive would be in place and that he was taking on board pension scheme concerns in relation to investment restrictions.
“Over the coming months, the Commission will continue to work closely with EIOPA (the European Insurance and Occupational Pensions Authority) to ensure that the final text hits the right note,” he said.
Sceptics however, may pay more attention to other areas of his speech, including a warning that reform would go ahead no matter what.
“I would like to insist on the need for this revision. We cannot allow ourselves to look only at the current situation,” he said. “We also have to take into account the safety of future pensioners and their trust in the system. If we do not start the necessary reforms today, there will be no guarantee that the occupational pensions paid out in 10 or 20 or 30 years will be adequate. This is a matter of our common responsibility towards future generations.”
Buscombe is hopeful that there will be room for compromise. “If the insurance sector is anything to go by when Solvency II was rolled out, then there should be some room to manoeuvre for schemes that are well advised and resourced to strategise and plan how they can position themselves vis-à-vis the regulations,” he says.
Elkhouly says that the directive is helpful, in the main, as it provides harmonisation, clarity and much needed transparency.
“There is no question that there are some potential issues to think about, but this has not changed the fundamental view that this is a sector that seems to be a very good match for pension funds,” he argues.
“My hunch is that people will realise that it’s important to facilitate long-term investment like infrastructure and hopefully the constraints will not be too onerous.”
He may be right. Barnier dropped another big hint in his speech in the Dutch capital, saying that he would seek new ways of encouraging long-term investment, “which is particularly essential for funding major infrastructure projects and the environmental transition”.
Even eager bureaucrats in Brussels might realise then, that changing this particular weather pattern is too dangerous an experiment, and will let nature take its course.
Written by Marek Handzel, a freelance journalist