UK: Institutional Investment: A Sector By Sector Review

Institutional investment is increasingly seen as a new method of funding infrastructure projects. Below, we consider a few sectors available for investment by institutional investors and assess the extent to which the National Infrastructure Plan (NIP) offers the right opportunities in these areas.

Social Housing

The National Association of Pension Funds (NAPF) supports social housing investments by pension funds stating that "it has liability-matching properties and the potential for investment returns much higher than those currently available on inflation linked gilts.14"

The opportunities offered by the sector are greatly shaped by the financial crisis and the Basel 3 capital requirements where banks have become very reluctant to hold long term illiquid assets such as housing investments on their balance sheet. The government in turn has cut almost 50% in grants to the social housing sector following the post crisis austerity measures. It is now estimated that housing associations will need to borrow around GBP 15 billion to fund planned regeneration and maintenance projects between now and 2015. All this combined with the government led rent increases for housing associations to be RPI plus 0.5% created just the right combination of factors to encourage pension funds and insurance companies to take advantage of the opportunities offered by the social housing sector.

Surprisingly, however, the NIP does not mention social housing or investments in schools or hospitals as an area of focus in its policy framework for UK infrastructure.

Given the social impact implications of this sector and the marked interest of pension funds and insurance companies, this oversight is regrettable.

Water

Some other areas of great social concern that will likely become more and more pertinent in the future given the events in recent years are water supply and sewage. The government issued a strategy policy statement to Ofwat, the water sector regulator, encouraging a greater attention to:

  • The impact of regulation in the field upon future investment prospects in the sector
  • The long term challenges faced by the sector, and
  • The sustainable development objectives

As a reinforcement of this trend, Ofwat's provisional price determinations for 2010-2015 provided for a major capital investment program of more than GBP 25 billion in water infrastructure (including GBP 13 billion of expenditure for capital maintenance), leaving water companies to prepare their business plans for meeting these infrastructure commitment targets. All this seems to promote a more investor friendly approach to the regulation of the water sector.

An increasing number of investors have begun to factor environmental, social and governance issues into their decision-making process and recognise their unique position to play a role in driving the transition to a more sustainable global financial system. Investment in water supply and sewage could be a great opportunity for institutional investors looking to diversify their portfolio and make a difference.

Renewable energy

Contrasting with NIP's complete lack of oversight of socially responsible investment in social housing, renewable energy has been an area which received much more attention. Several factors can be found in the NIP to support institutional investment in this sector including:

  • The liberalised market
  • The Electricity Market Reform package of measures being implemented by the government in order to meet the renewable energy target set for 2020
  • The government's legally binding carbon commitments
  • The government's plan to implement the Contracts for Difference (CfDs) in the low carbon generation technologies, and
  • The government's plan to implement a favourable tax regime for shale gas

All these factors should support institutional investors in renewable energy by decreasing some of the risks associated with investing in this sector.

The CfDs will protect investors from fluctuations in the wholesale electricity price, will provide increased certainty about future revenues and help reduce the initial cost of capital. The government also intends to include other contract terms such as the providers' flexibility to reduce capacity, protection against unexpected events and protection against change of circumstances. Renewable energy therefore provides a clear option for institutional investors both by favourable market conditions as well as by undoubted government support.

A project focused approach

Given that 40% of the government's pipeline of projects is already under construction, it is also important for institutional investors to focus on sectors where the government has not yet identified key projects within the NIP policy framework and where it adopts a more flexible approach as to the type of projects available for consideration.

The government encourages projects in gas and unconventional gas production, wind energy, biomass, solar PV, wave and tidal energy and states that it will monitor investments in these sectors at a program level despite not identifying specific projects.

There is significant scope for government led financing in these sectors if a suitable project is put forward by the investors and institutional investors should consider these opportunities.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Corina Barsa
 
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