The emergence of high inflation and net-zero objectives are encouraging institutional capital flows into infrastructure, but a cost-of-living crisis and growing risks of political and regulatory intervention mean investors face a difficult balancing act.
A survey by 91传媒在线 found that institutional investors are looking to infrastructure allocations to protect against inflation and to contribute to the energy transition, but political/regulatory intervention is the most concerning risk.
The findings were echoed by a panel of investors at the in Amsterdam.
Stephen O鈥橬eill, head of private markets at Nest, said the fast-growing UK pension fund had been attracted to infrastructure for its inflation protection and Nest鈥檚 own 鈥渁ggressive net-zero target鈥�, alongside its low volatility and the potential for pension-fund member engagement.
鈥淥ur investment objectives for our members is to deliver an inflation-beating return over their savings career. And other than index-linked gilts, there are little to no other assets which have quite the same inflation correlation,鈥� he said.
鈥淲e鈥檙e trying to aggressively move towards halving the portfolio emissions by 2030, and there鈥檚 only so much you can do by tilting and weighting things in listed equity portfolios. But actually generating renewable energy 鈥� or converting diesel engines to hydrogen or electric engines in the transport sector 鈥� makes a huge and tangible difference to that decarbonisation.鈥�
According to the survey by 91传媒在线, 56% of institutional investors believe their infrastructure investments have provided a hedge, although 41% said it was too early to tell. Meanwhile, 70% said they were confident that infrastructure portfolios would provide a hedge going forward (26% were unsure).
鈥淚t鈥檚 a very important part of what the asset class offers,鈥� said Simon Davy, head of real assets at the UK鈥檚 Local Pensions Partnership Investments (LPPI), who was also speaking on the panel. 鈥淲e鈥檙e looking at long-dated inflation linked liabilities for our ultimate investors and pension clients.鈥�
When asked to give reasons for investing in infrastructure, survey respondents repeated four key factors: stable cashflows, inflation protection, diversification and ESG/energy transition.
Other findings reinforced the importance of the latter. Waste/water, and solar and wind energy were the three most favoured sectors, while 74% of investors said they had an explicit objective or intention to contribute to the energy transition and net-zero agenda through their infrastructure investments.
NN Group first allocated to infrastructure several years ago for its diversification benefits, but Marieke van Kamp, head of private markets at the Dutch insurer, told the panel that 鈥渋n time, it developed really into more and more a focus on climate solutions鈥�. Van Kamp said the strategy is 鈥渕uch more focused now in in the renewable space and in the energy-transition space鈥�.
But while inflation protection and a desire to invest in clean energy are strong incentives, the survey showed that investors are concerned about the cost-of-living crisis fuelled by inflation and the potential for popular and political pressures and policy changes. Political intervention and regulation, collectively, was cited as the greatest risk facing infrastructure investments by more investors (30%) than any other, followed by valuation uncertainty and availability/cost of debt.
Jamie Clark, director of infrastructure debt for EMEA at , which manages capital on behalf of US insurer MetLife and third-party investors, said private markets, and infrastructure debt in particular, have continued to 鈥減rovide a really good diversification from the traditional public fixed-income markets鈥� and recent crises have 鈥漞mphasised the stability of the asset class鈥�.
But, he said, concerns about political and regulatory risk had 鈥漛een more prevalent in the past couple of years鈥�.
He cited the Finnish electricity regulator, which carried out a 鈥渕id-period adjustment鈥� to prices. 鈥淚t wasn鈥檛 drastic against cashflows, but the fact that it was a mid-period change goes against the transparent nature, and so they were downgraded one notch and that then has an effect on the cost of debt they鈥檙e able to raise.鈥�
Nest, a large defined-contribution fund that invests the retirement savings of UK employees that are 鈥榓uto-enrolled鈥� into the pension scheme, has recently made a big push into renewable energy and has benefitted from recent rises in energy costs.
鈥淲e鈥檝e got quite a lot of renewables and we鈥檝e been able to benefit from that surge in the energy price,鈥� O鈥橬eill said. 鈥淚t鈥檚 driving inflation and we鈥檙e making money from it.鈥�
But the situation raises questions for an investor like Nest, which has to factor in the objectives of regulators and the wider interests of its own members. 鈥淭he countervailing thing is whether or not regulators feel comfortable allowing all of that inflation to flow through to customers,鈥� O鈥橬eill said.
鈥淥ver 10 years, the UK regulators have actually been鈥� quite investor friendly 鈥� I think it鈥檚 fair to say 鈥� about passing inflation through to customers, although for the last 10 years that was probably quite easy for them, because inflation was quite low.鈥�
He added: 鈥淲e also need to not lose sight of the fact that, as a pension scheme, the investors are [also] the customers鈥� at a certain point it becomes a little bit perverse to think about whether or not, by ratcheting up the cost of these services and the cost of these commodities, you鈥檙e really improving the financial wellbeing of your scheme members. I think in high-inflationary environments, possibly you鈥檙e not.鈥�
Davy said: 鈥淎t the minute, the consumer has paid a lot, and I have a lot of sympathy with Stephen鈥檚 view. Probably top of my list of worries is political and regulatory risk鈥� politicians perhaps want to distance themselves from taking the tough decisions and maybe try to pass that on at some point, given the cost-of-living crisis that we know affects a lot of people around the world.鈥�
Impact investing and pension engagement
The panel was asked whether the focus on contributing to the energy transition meant they were becoming 鈥渋mpact investors鈥�, and van Kamp said the weight of capital moving into renewable energy for net-zero purposes had meant 鈥減rices are becoming sharper and sharper, which then lead to discussions with the risk department on, is this a good balance鈥� between returns and environmental impact?
O鈥橬eill said the impact element of renewables and other forms of sustainable infrastructure was important for a DC pension scheme that is looking to increase member engagement.
鈥淒C savers in the UK are terribly disengaged from their pensions but, if you can point up to a wind turbine鈥� and say you own that, our research and our experience is that, especially with younger people and especially with renewable assets, they become more engaged and more interested in and feel more positively about their pension.鈥�
Katherine Laurenson, head of alternatives distribution for EMEA at Legal & General Investment Management, said that the recent rise in bond yields, which has reduced the differential between fixed income and private infrastructure, has made the positive impact of investing in renewables all the more important. 鈥淚t almost has to have impact to make sense in that context,鈥� she said.
鈥淵ou can say that categorically we are adding and doing positive things to impact a better future, and then it comes down to data points and proving [it] to investors.鈥�
As the size of defined benefit pension funds in the UK decreases and DC pensions predominate as the main source of retirement capital, the issue of member engagement and infrastructure鈥檚 role in that will only become more important, she said.
鈥淲e were the largest manager of DB money in the UK and that鈥檚 going,鈥� she said. 鈥淎nd so [with] the DC money, we鈥檙e really having to respond to the 35-year-old who鈥檚 just started on their career path and they do want to see their money have real impact.鈥�
However, the DC pensions industry in the UK has broadly been set up to invest in assets and funds with daily liquidity. 鈥漈he operational and liquidity issues that we have to overcome are quite significant,鈥� Laurenson said. 鈥淏ut the traditional private fund model doesn鈥檛 actually work very easily at all for the DC capital.鈥�
She added: 鈥淏ut that doesn鈥檛 mean to say there isn鈥檛 a huge desire, and regulatory and policy push to get that capital into it for all the right reasons 鈥� impact but mostly the returns and growth that is required for that kind of younger cohort. So I think that鈥檚 the challenge we see, but hope to solve for the DC market. And it鈥檚 a huge opportunity if we can get it right.鈥�
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