Keynote Interview
UK pension funds are in a hole when it comes to likely future returns.
Arjun’s Surinder Toor argues investing in infrastructure is a vital way out
Arjun Infrastructure Partners, an independent asset management firm dedicated to identifying, executing and managing European mid-market infrastructure investments with offices in London and Paris, was founded in 2015 by Surinder Toor. In contrast to many infrastructure outfits following a more typical private equity model, the firm focuses on offering long-term investors – such as pension funds – the chance to own cashflow-producing strategic assets for the long haul.
Arjun has investments across OECD-Europe, with the majority of capital having been raised from large international pension funds and insurance companies from around the globe. Toor highlights that UK institutional investors are behind their overseas peers as domestic investor allocations to UK infrastructure are currently strikingly low.
Q Why are allocations to UK infrastructure so low?
You have to understand the background. There has been a sea change in the UK pension industry in the last 20 years. We have seen the defined benefit schemes withdraw completely from equities and switch assets overwhelmingly into bonds. This was driven by actuarial calculations and a desire to de-risk portfolios.
In consequence, what we now have is a very strange situation in the UK. Our political leaders fret about low levels of foreign direct investment and yet the reality is that what is missing is significant purchases by our domestic pension funds.
It is striking that while the UK is the largest investable infrastructure market in Europe, the investments are overwhelmingly funded by overseas investors. Even though the level of interest in the UK has softened post-Brexit, the share of UK investors in UK infrastructure remains relatively small.
In the last 20 years, government has essentially allowed, and actually encouraged, a cut off in the supply of capital to equity markets. It has also allowed a situation where the vast majority of pension savings are now held in assets which are proven over the longer term to provide the lowest returns.
Historically, the equity returns, both public and private, have been higher than the bond returns in the long term. For UK pensioners, someone will have to make up the difference. Probably UK taxpayers and pensioners, which are mostly the same people.
Q Should pension funds be looking at private equity infrastructure investments?
Absolutely. It is very important that pension funds should move away from locking in low returns and seek higher risk-adjusted returns. Private equity investments in infrastructure are the best way to do that.
While infrastructure allocations for some defined contribution schemes are as high as 5 or 6 percent (compared to 15-20 percent in the Nordics, Australia and Canada), most of the large defined benefit schemes in the UK have virtually no infrastructure exposure in their portfolios; they are trapped in low-performing assets. This is the perverse thing, as all of this has happened as an attempt to de-risk portfolios and yet the reality is that a significant level of risk has been locked in by this asset allocation. My great fear is that this trend will continue.
It is also perverse that at a time of rising environmental and sustainable growth considerations, UK pension funds have essentially abdicated their responsibility by withdrawing from equity markets and continue to have very low weightings in infrastructure, one of the investment sectors where they can have the biggest impact on society.
The big picture is that we absolutely as a society need our pension funds to allocate more to equities and private equities in the right way, for their sake and for ours.
Q What are some real-world investment examples that tie in with the themes you have identified?
I immediately think of one recent investment which we made in a fibre business in France – Altitude Infrastructure. It is a very good example of how essential infrastructure can be provided that is highly beneficial to the public/end-users and investors with a long-term mindset when a government has a sensible policy towards rolling out new infrastructure.
In the UK and in Germany there has been rather a ‘free-for-all’ in fibre, creating a very real danger of overbuilding. In some roads you can see three different fibre networks being put in simultaneously, but by contrast France has a far more sensible policy where it allocates local monopolies to particular partners, removing that overbuild risk.
The French government has coupled this with a policy decision to remove copper completely by 2030. Overall, this means that the French market structure is far more sensible in achieving good outcomes for consumers, for investors and ultimately for taxpayers.
Another interesting investment is in the transportation area, with the motorway service station operator Welcome Break. This illustrates the gradual transition of infrastructure as a sector away from low-risk utility, towards higher-value client servicing.
In the next 10 years we expect to invest over £200 million ($254.1 million; €232.2 million) rolling out electric vehicle charging points across the estate. As people stop to recharge their electric vehicles they will make ancillary purchases. This will transform what is currently a steady, but perhaps unexciting, investment opportunity into something with considerable upside.
Q Have pension funds been discouraged by the controversy surrounding Thames Water?
Yes, I fear that they have been. And yet the reality is that the Thames Water debacle is the consequence of government and regulatory failure.
There is strong evidence that privatisation leads to greater efficiency of asset operation and to more capital being invested. This is what we have seen in the water industry since 2010. Something like £160 billion ($203.2 billion; €185.8 billion) of capital expenditure has been delivered; if privatisation hadn’t happened, neither would that significant capital expenditure.
But the sad reality is short-termism and political interference also increased after 2010, and there was strong political pressure to reduce the funding of capital expenditure to avoid increasing bills to customers. This short termism has meant that no reservoirs have been built and water infrastructure, especially on the wastewater treatment side, has been allowed to deteriorate and our physical environment has had to suffer significant environmental harm. We can see the same consequences of short-termism in health, social services and defence.
Q Is there hope that this will change, and what role can investors play?
I think reality has begun to dawn and it is gradually being understood that significant increases in capital expenditure have to be made in order for the industry to catch up with all the work that needs to be done.
Water has always had a more politically charged stakeholder engagement, perhaps because of its lineage rooted in the thousands of municipalities’ waterworks that are the background to the current industry. However, the nuances of the impacts of short-term cuts to capital investment having a direct impact on customer service and poor environmental outcomes are often overlooked. If you look at electricity and gas, there has always been a much more balanced approach to regulation.
Companies obviously dropped the ball here under pressure from governments and regulators, but investors also have a role to play. They need to stand up to political interference. Sometimes, investors should be helping companies to make the argument for higher prices, otherwise we will end up in the kind of crisis which began the British water industry in the mid-19th century – the Great Stink of 1858. It is also part of the investor’s role as a good steward to make sure that high-quality customer service remains in place. This is what an ESG framework really is about.
Q Where are the opportunities for pension funds in infrastructure now?
There are myriad places pension funds can find opportunities. We see so many legacy assets across the UK that need reinvestment, particularly in water and electricity. The latter is made all the more urgent by the decarbonisation of transport through electrification, which will lead to a significant increase in demand for electricity, as well as the more general question of how to provide baseload power in a country that is now so reliant on offshore wind. The UK power grid needs massive investment to be upgraded and there are various opportunities around this. That includes areas such as storage, or even new potential fuel sources, such as hydrogen. In addition to this, the push for greater connectivity requires a continuing rollout of fibre to homes across the UK, while the rise in AI multiplies the requirements for more energy and better connectivity, data centres and further higher capacity within the grid. We are also seeing many new opportunities in so-called ‘social infrastructure’, most especially in senior living and healthcare, which are going to be central in the next few decades as our society is aging in tandem with the rest of the industrialised world.