The EDHEC Infrastructure & Private Assets Research Institute has highlighted the risks for defined benefit (DB) pension schemes of investing ‘productive finance’, including infrastructure, in its response to the Department of Work and Pensions’ (DWP) Options for Defined Benefit schemes: a call for evidence.

The Institute underlined the advantages of this asset class for long-term investors, particularly pension funds, but drew the DWP’s attention to the risks of this category of assets, which it considers to be poorly captured by investors.

On the benefit side, EDHEC’s response said that through their superior duration, risk-adjusted returns, stability of cash flows and good level of decorrelation with public assets, unlisted infrastructure investments present indisputable advantages, whether in improving the performance of DB pension funds or improving their liability hedging.

On the latter point, infrastructure debt can be a good replacement asset in the context of deleveraging liability-driven investment (LDI) strategies.

However, on the risk side, “it is not so much the size of the risks as their poor measurement, and therefore their poor management”, that is underlined in EDHEC’s response.

Investors face significant hurdles to invest in infrastructure in a manner that is in line with their prudential and fiduciary responsibilities, the Institute added.

”The main stumbling block preventing the widespread development of infrastructure investment amongst DB plans in the UK is the type and quality of data available to investors in such assets has been remarkably poor and unreliable,” it noted.

The tendency to rely on contributed appraisal data, which is common in private markets, and not on information that accurately represents the risks of the asset class, masks the true characteristics of these investments, and precludes any rational decision-making process when it comes to investing in infrastructure, it said.

“In our response, we show that while on aggregate infrastructure has a lower volatility than its public counterparts, there have also been multiple cases of infrastructure companies going bankrupt or face significant write downs.”

EDHEC has noted that robust data enables an investor to be aware of these risks and, more importantly, manage them in a timely manner.

”As long as fair value and risk are not properly measured, UK DB plans will continue to either not invest in infrastructure or fail to invest wisely and face the consequences of not managing the risks, as the recent episode of the multi-billion-pound loss faced by Thames Water investors, some of which are UK pension plans, illustrates.”

In conclusion, the Institute nonetheless underlines that the right data to measure the financial and non-financial risks of unlisted infrastructure now exists and investors should take the measure of its importance in better managing their infrastructure investments.

In this context, EDHEC is recommending that The Pensions Regulator set up best practice rules and require pension funds to show that they have a serious investment and risk management process for this asset class.

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