UK pension funds set to boost infrastructure investment amid volatility

Pension schemes in the UK are set to increase their investments in infrastructure, with the asset class emerging as a key diversification tool in the face of economic uncertainty.

According to the Pensions Policy Institute’s latest report – Pension scheme assets – a deep dive into infrastructure – pension schemes currently allocate just 1-3% of their assets to infrastructure, a figure that is expected to rise substantially as funds mature and seek more resilient, inflation-protected returns.

The report, sponsored by the Association of British Insurers (ABI), is part of the PPI’s broader pension scheme asset strands study and explores how patterns in investment into alternatives have changed in the past, where investment is today, and how it might change in future, and asks what all this means for schemes and members.

Defined benefit

For defined benefit (DB) schemes, infrastructure provides attractive characteristics such as long-term, stable cash flows that are well-suited to match liabilities, the report noted.

Notably, Local Government Pension Schemes (LGPS) have demonstrated growing interest in this space, particularly in green and renewable infrastructure projects, which accounted for 6% of LGPS assets in 2023.

The report also showed that there’s a growing focus on investing in renewable energy infrastructure, such as solar, wind and hydroelectric power projects. Ongoing geopolitical tensions and increased digitisation have reinforced the importance of energy security more broadly and the rapid digitisation of economies worldwide has led to increased investment in digital infrastructure, including 5G infrastructure and fibre optic networks.

Defined contribution

On the defined contribution (DC) side, schemes have faced challenges in scaling up infrastructure investments due to limited expertise and higher associated fees. However, the government’s Mansion House Compact and recent regulatory shifts, including changes to the Solvency II Matching Adjustment rules, are expected to encourage more schemes to invest in productive finance, including infrastructure.

Larger DC schemes are also consolidating, which could enable better access to the asset class, PPI stated. It is expected that the introduction of the Value for Money framework will further accelerate the pace of consolidation among smaller schemes that may be underperforming.

“Consolidation of smaller schemes is a common feature of both the Australian and Canadian pension systems where pension scheme investment in infrastructure is greater,” the report noted.

In addition to consolidation, the scale of master trust assets in particular is growing relatively rapidly as automatic enrolment continues into its second decade and savers who were newly brought into pension saving by the policy build greater levels of DC savings. As DC schemes achieve greater scale, either through consolidation or growing contributions, they may have more capacity for investment in infrastructure projects that are currently inaccessible to them, the PPI said.

ESG

The report also underscores the increasing importance of ESG considerations, with pension funds aiming to contribute to environmental sustainability and social impact through infrastructure projects. However, the limited supply of high-quality assets and evolving risks – such as climate-related challenges – pose ongoing barriers to further investment.

Overall, the infrastructure sector’s potential to deliver both financial stability and ESG benefits makes it an attractive option for pension funds looking to weather economic volatility and meet long-term obligations, PPI said.

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