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Analysis - Social infrastructure may lure risk-shy pension funds
LONDON (Reuters) - Pension funds may start investing some of their cash mountain now idling in low-yield government bonds into infrastructure, but only if they can find projects that are resistant to economic swings and bring immediate cash flows.
The idea that cash-strapped governments could seek help from pension funds, which control assets of $35 trillion (21.82 trillion pounds) globally, got a boost after Britain secured 2 billion funds from them last year for new projects by 2013.
But this is far short of a 20 billion target and many pension funds shy away from investing in infrastructure, even though they are ideally placed to bridge the funding gap left by banks which are forced to tighten lending to meet capital rules.
This is largely because pension funds prefer to stick to low-risk and low-yielding fixed income with the aim of better matching their assets with liabilities.
Possible infrastructure investments range from low-risk and stable public assets such as schools, hospitals and rail networks to those that have private-equity style risk profile and are highly leveraged.
But experts say pension funds are more interested in social infrastructure, including schools and hospitals, which are already built and give a stream of income paid by the state. This removes both construction and revenue risks.
The one that may not tempt them much is demand-based, economic infrastructure such as toll roads, airports and power generation, which are highly exposed to business cycles, leveraged in a private equity style and have revenue risks.
"There is lots of rhetoric around infrastructure but no one has untied the knots," said Giles Frost, chief executive officer of specialist manager Amber Infrastructure.
"Pension funds want low-risk investment. Lower risk infrastructure is availability-based (projects). They have long-term sustainable yields and inflation protection."
Since the idea of bringing in private capital to public projects was launched in the 1990s in Britain, one of the hurdles for pension funds has been the high perceived investment risk, especially surrounding infrastructure debt.
When investing in the primary infrastructure market - projects that are yet to be built - investors commit their money first but must wait at least 2-3 years for projects to complete and generate cash flows. During that period, their money is tied but earning nothing.
Then there is the issue of credit quality. Infrastructure debt typically has a lower investment grade rating of triple-B, even though it is backed by triple-A governments, in part because of long maturity of about 8 years and the possibility that construction may not complete.
The subprime crisis and the collapse of Lehman Brothers also effectively closed the market for "monoline" insurance, which enabled these lower-rated projects to get triple-A thanks to the backing of insurance companies.
Some infrastructure funds - debt or equity - often promise higher returns of 10-15 percent and had a similar type of characteristics as private equity.
"We prefer a newer type of infrastructure funds rather than PE-look alike funds. We like funds that look at 25 years or more and produce long term stable returns, rather than those that flip assets quickly," said Mike Taylor, chief executive of London Pensions Fund Authority, which manages over 4 billion pounds.
"If I get the retail price index plus 5 percent I will be happy in the next 25 years. The stability of return is important," he told an Infrastructure Journal conference.
Many pension funds still categorise infrastructure as alternative investment, under the same bracket as hedge funds and private equity, rather than equity or fixed income which comprise the bulk of their asset allocation.
They typically target a higher return of 10-15 percent from the risk budget in alternatives. Therefore, lower-risk infrastructure funds with the typical return target of around 8 percent sometimes do not meet pension funds' criteria.
According to a survey of over 1,100 European pension funds with assets of more than 550 billion euros ($732.43 billion) by consultancy Mercer, average asset allocation to infrastructure among European pension funds stood at just 3.2 percent last year.
Only 4.9 percent of respondents said they look to boost infrastructure. In Britain, this drops to just 2.8 percent.
Infrastructure investments are not always high risk. According to Infrastructure Investor magazine, only 8 out of 667 public-private partnership projects launched in the UK since 1990s have defaulted.
One project finance manager at a London-based bank said the average recovery rate on the defaulted debt has been 90 percent.
On the equity side, UK-listed infrastructure investment funds enjoy an average dividend yield of over 5 percent, comparing favourably with the broader UK market .FTSE yield of 4.1 percent and gilts that return next to nothing.
Listed funds, whose market cap stand at 2.1 billion pounds, could be more appealing to pension funds given that they are more transparent, liquid and often command lower management fees than unlisted funds. ($1 = 0.7509 euros)
(editing by Ron Askew)
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