The golden years of 30 per cent returns may be over, but there is still a lot to attract UK DC pension schemes to infrastructure investments says Frédéric Blanc-Brude, director at EDHECinfra, the research and indices provider for infrastructure investors.
UK DC portfolios’ heavy exposure to equities and near-total absence of infrastructure holdings was not problematic in the decade following the global financial crisis, while returns were strong. But in today’s more challenging investment markets, the diversification offered by infrastructure is seen as one of its key benefits.
So what are the diversification attributes of infrastructure? Blanc-Brude, says: “What we see is a 40 per cent correlation with bonds.”
The diversification Blanc-Brude talks about would have been welcomed by DC portfolios in 2022, when pretty much all asset classes held by schemes performed badly. While equities and bonds tanked, EDHECinfra’s Infra300 equity index, when represents the quarterly performance of 300 unlisted infrastructure companies, saw a positive 4.92 per cent return – following 16.14 per cent in 2021, -1.85 per cent in 2020 and 13.55 per cent in 2019.
Champions of the approach of Australian super funds point to the strong performance they have enjoyed through their infrastructure opportunities. Blanc-Brude suggests that golden age may have passed, and that infrastructure’s diversification and cash-generative attributes are its key positives today. “Historic performance of infrastructure has been great. You could say that this was performance driven by excess demand. Infrastructure is good at generating cash. Nothing creates as much cash as infrastructure, but don’t expect to have the same yield as previously – it’s over.”
To illustrate the point, the Infra300 equity index delivered 21.9 per cent and 32.84 per cent in 2013 and 2104 respectively, but hasn’t beaten 17 per cent since.
Still, the cash-generative and diversification attributes of infrastructure mean it should be a tool in the DC investment manager’s armoury – so what is holding it back?
“The large DB funds have their own teams. But it can take 10 years to build up a portfolio of around 20 assets. Diversification in infrastructure investments is difficult to achieve. Volatility only starts to taper off when you have 200 assets in the portfolio,” says Blanc-Brude.
He adds that the cash-generative nature of infrastructure makes it an obvious tool for managing liquidity in DC schemes. “You are better off managing liquidity through infrastructure than other illiquid investments like private equity as you get the cash flow.”
Blanc-Brude points out that many infrastructure projects do have a shelf life. “Most infrastructure investments are projects – for example a wind farm. It runs for 25 years and then it is over. The value of the asset decreases over time and it amortises, which makes it great for decumulation investments.
Cost is one of the other factors that have held back infrastructure and other private market investments in DC, despite the government’s drive to relax the charge cap. Pension providers regularly bemoan losing a pitch for a DC scheme on a couple of basis points on price, so even if infrastructure fund charging structures have come down, price will remain an obstacle for many schemes until attitudes towards the diversification attributes of the asset class become more positive.
Blanc-Brude says a 2 and 20 fee structure, with an 8 per cent hurdle, is typical. “But fees have come down, and infrastructure managers do offer a diversification across multiple investments, and you don’t have the expense of running your own team.”
Blanc-Brude is a frank talker who is not fearful of sharing strong opinions. Last year he and his colleague Noël Amenc, associate professor at EDHEC Business School, wrote an open letter to controversial former HSBC Asset Management head of responsible investing Stuart Kirk, accusing him of ‘spreading fake truths to sound clever’. Kirk had delivered a provocative presentation outlining why investors need not worry about climate change. Blanc-Brude and Amenc accused Kirk of relying on dubious statistical methods and an absence of understanding of finance.