U.K. defined contribution plans could enjoy the benefits of investing in infrastructure to the same extent as their defined benefit counterparts, but scarce investment options combined with misconceptions about accessing the asset class are holding newer plans back, industry sources said.
In an attempt to capture an illiquidity premium and inflation protection — at the same time as gaining returns that have a low correlation with the equity investments typically dominating newer portfolios — appetite by U.K. DC plans for infrastructure is rising, sources said.
The £1.8 billion ($2.3 billion) National Employment Savings Trust, London, is looking to gain infrastructure exposure and is actively meeting with managers to develop a solution specifically for NEST, said Mark Fawcett, chief investment officer at the plan, which launched in 2011.
"We are enthusiastically looking for the right solution. The combination of natural inflation-hedge and illiquidity premium that infrastructure offers … is attractive for us as a long-term investor. We are interested in both equity infrastructure as well as debt infrastructure. And we are speaking to managers (about) how we can create a solution for our default fund at a low fee," said Mr. Fawcett.
He said executives plan on allocating to NEST's real assets portfolio, which has a maximum allocation of 20% of the trust's assets and currently consists of real estate. Infrastructure could make up 15% to 20% of the real assets portfolio, he added.
"Infrastructure equity could also be included in that real asset allocation bucket. We could do a bit more with infrastructure debt as part of credit investments," he added. He declined to disclose the names of managers NEST executives are in discussions with.
Despite efforts by consultants and plans, the industry is yet to explore the scope and format best suited for DC funds, sources said. DC plan sponsors have opted to stay away from the operational complexity that comes with illiquids, not only in the U.K. but also in other markets such as the U.S., where daily valuation, liquidity and fees are often cited as obstacles to adding illiquids.
Largest funds only?
Because a typical direct infrastructure investment requires a minimum £100 million allocation, it is only accessible to the largest funds, many believe.
"Nobody wants to do it first. Managers want to do it but they are worried about demand," said Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits in London.
Catherine Doyle, head of DC at Newton Investment Management, added: "In addition, there is lack of interest from platforms because they are hesitant to take on the additional risk. There needs to be enough demand to justify the risk."
Some U.K.-based sources said that the issue holding back infrastructure investment by DC plans is the assumption that the regulation requires that investments to be subject to daily pricing and liquidity. However, Ms. Nazarova-Doyle said a review of rules on infrastructure investing by the Law Commission, released in June 2017, has said that those rules do not require daily dealing or daily market valuations.
Ms. Nazarova- Doyle added that many clients may not realize that daily dealing and valuations is not a platform requirement — allowing to add exposure to infrastructure for DC plans.
Meanwhile, some investors have begun to use products available in the market, which offer daily pricing.
Alex Pocock, partner and head of DC investment at actuarial consultant Barnett Waddingham LLP, London, said one of his clients has so far committed to Partners Group's Generations Fund, which combines access to private equity, private debt, private infrastructure and private real estate.
The fund, developed in 2016 specifically with U.K. DC plans in mind, offers daily pricing, which many of the existing alternatives/infrastructure DC solutions in the market lack.
Joanna Asfour, senior vice president and global head of consultant relations at Partners Group in London, said the firm is bringing on two major U.K. corporate-sponsored DC plans onto its platform in the coming months — one in the fourth quarter of the year and one in the first quarter of next year. Ms. Asfour declined to name the funds.
Some U.K. plans are gaining small exposures to infrastructure through diversified growth fund allocations. However, JP Crowley, senior DC consultant at Mercer in Edinburgh, said "illiquid assets have the potential to provide much greater diversification than is achievable through these types of liquid multiasset funds."
NEST's Mr. Fawcett said that infrastructure should be an element of a DC plan — in part due to the long-term investment horizon.
"The key challenge is that usually closed-end infrastructure funds are available in this space and these are not useful. We would not be looking to exit in 10 years time in the same way as a defined benefit fund would. Our time horizon is 30 to 40 years so we are looking for open-end solutions. For us, it would really not be an off-the-shelf product," he said.
Cost, too, remains an obstacle, with manager fees taking up between 10% and 20% of cost budgets. Ms. Doyle said allocations to illiquids would have to sit outside of the charge cap, which is currently 75 basis points.
Mr. Crowley added that if only a small proportion of participants' assets are invested – up to a 10% allocation – the aggregate fee becomes much more palatable, particularly when combined with lower-cost investments such as passively managed equities.
But this approach leaves DC plans very little room for maneuvering because the diversification aspect of the investment becomes more limited.
Ms. Doyle agreed that a number of DC plans are currently reflecting on investing in less liquid asset classes such as infrastructure, but she was not aware if any has actually pulled the trigger.
"But the demand is likely to come from larger plans – particularly trust-based," Ms. Doyle said.