The UK government’s Build Back Better growth plan paves the way for significant investment in infrastructure, which could be attractive for defined contribution schemes. How might they take advantage of opportunities to improve outcomes for savers?


Callum Stewart

Infrastructure is commonly defined as the facilities and essential services required for the effective functioning of modern economies. It is an asset class of considerable diversity; this makes it challenging to evaluate specific opportunities but also underpins its diversification potential.

Within the diverse opportunity set, there are a range of investment opportunities with different risk and return characteristics. 

After costs and charges, the potential (inflation-linked) returns from the asset class are attractive for long-term investors such as DC schemes, albeit high-quality managers are needed to navigate a complex universe. 

For example, at the lower-risk end of the spectrum, investors may expect returns of 4-6% per year for participating in the financing of a government-backed solar farm. At the higher-risk end of the spectrum, investors could expect returns of 15% per year or more, for example, through investment in an early-stage emerging markets offshore wind facility. For DC schemes, we anticipate investment in well-diversified portfolios with a return potential of up to 8% per annum. 

Infrastructure has a significantly different return stream from equities and bonds, meaning there are opportunities to improve diversification in portfolios while maintaining or potentially improving longer-term return expectations.

By definition, infrastructure investing means investing for the future. Many pension schemes are putting in place longer-term goals to address climate change and infrastructure may be an attractive asset class to explore to progress towards interim climate targets, such as through climate solutions.

DC schemes, within the scope of the Taskforce on Climate-related Financial Disclosures (TCFD) requirements, will need to put in place appropriate climate metrics and targets. Infrastructure investment could be part of the solution. Infrastructure investments can also contribute positively to society by providing jobs and the opportunity to develop skills needed for the future and a more sustainable world.

Generating a positive impact on the world by investing in tangible infrastructure projects also provides opportunities to engage DC savers – we think savers will respond positively to news that their money is being used not just to generate good returns, but also to do good in the world.

Governments in many countries are showing greater awareness of the socioeconomic costs of sluggish productivity growth and wealth inequalities, and the role high-quality infrastructure can play in addressing them. 

Appetite for action

An important reason for the increased demand for infrastructure financing is poor government finances, especially post-pandemic, so need private capital to invest in infrastructure. The Build Back Better and Levelling-Up policies suggest a greater appetite to take concrete action. In the UK, the government’s net-zero strategy calls for £695-825bn (€825-980bn) of public and private sector capital to be mobilised over the period 2022-35 (£45-55bn per year), much of which will be invested in enabling infrastructure. 

What is the potential role in DC strategies?

DC savers can afford to take more risk in the earlier stages of their savings journey, provided this risk is expected to be rewarded over the longer term. We think infrastructure investment has a role to play through the accumulation phases of a glidepath, and into retirement for those targeting income drawdown. 

Based on the level of returns we would anticipate from the asset class, infrastructure has the potential to improve retirement outcomes for DC savers by up to a fifth based on an allocation size of up to 20% of assets. 

For infrastructure investing, a long-term time horizon is critical as underlying capital deployed within funds may be locked away for 10 or more years. Infrastructure investments can also take a number of years to ‘ramp-up’. In other words, it can take time for asset managers to navigate the complex infrastructure universe and put capital to work. This period is typically around three years, but it can take longer. 

We think blended funds are now an essential feature for future proofing DC schemes’ investment strategy, and these can help overcome many of the barriers to investing in less liquid assets more generally. Blended funds permit changes to the underlying asset allocation, without creating onerous consultation and reporting requirements each time a change is made. It is also possible to manage cashflow pragmatically, with more liquid components used to facilitate cashflow and greater scope to leave less liquid investments alone.

From a pure investment perspective, the long-term capital commitment should not be an immediate concern for DC schemes due to savers’ very long time-horizons. Indeed, there is an alignment of interests in terms of time horizon and corresponding opportunities. A key risk is facilitating cashflow, particularly during periods of market stress. In practice, cashflow would be fulfilled using liquid assets. 

Focusing on outcomes

Here are some specific actions that can be to improve outcomes for members, as well as integrate climate and wider sustainability goals.

Schemes should seek guidance on infrastructure investment. This should cover risk and return characteristics including social and environmental impacts, as well as how the asset class could be implemented within existing structures.

Schemes should engage with providers and advisers to understand how they may be able to access infrastructure opportunities. Platform capabilities will be key. As part of their investment strategy review, schemes should explore how infrastructure and other illiquid assets can be used to improve outcomes for members. Reviews should attribute a weighting to platform capability, given that a lack of functionality could stifle schemes’ ability to deliver good outcomes for members.

If schemes identify opportunities to improve outcomes, they should take action to capture them for the benefit of members. They should work with with their provider and advisers to introduce allocations to infrastructure and illiquid assets over a reasonable time period.

Schemes should share positive stories with members about the action they are taking to improve outcomes. Infrastructure investments have strong potential to create engaging narratives about how members’ money is being used to build a more sustainable future.

Callum Stewart is head of DC Investment at Hymans Robertson