How to create investable UK opportunities for pension funds

Since pension funds’ overarching fiduciary responsibilities to their members require their investment decisions to be based on risk and return considerations, the government needs to take a strategic approach to mobilise greater pension fund investment towards the UK.

However, the challenge facing pension funds is in finding suitable UK investment opportunities. To assist in addressing this, the government needs to deploy targeted incentives to specific UK projects or places and thereby improve the risk-adjusted return for such investments. The government’s plans to deploy “catalytic” funding and use “blended finance” techniques will enable selected UK opportunities to “crowd in” more institutional investment, especially from pension funds.

Such targeted incentives will be used to address the barriers that can otherwise deter private capital being invested into UK opportunities and thereby “catalyse” this additional funding.  Mobilisation for pension funds can be provided by growth programmes such as the National Wealth Fund and the British Growth Partnership and will potentially encompass a wide range of products, financial instruments and other forms of assistance.

First loss funding

First loss funding can be used to alleviate concerns on the extent to which pension funds will bear potential losses on a UK investment. Depending on the funding structure, first loss funding often takes the form of junior debt or equity which only receives returns once more senior interests are repaid and/or would suffer any losses ahead of the more senior interests. Growth programmes are typically focused on making investments, rather than awarding grants, through routes such as taking subordinated interests in an asset. In this way, growth programmes can look to achieve their aims of catalysing investment whilst receiving returns which can then be recycled for new funding.

Return enhancement

Return enhancement can be used to address the prospect of there being insufficient financial returns. Again, this can take the form of various credit enhancement such as guarantees. Pension funds may also seek wider price assurance options, including through the use of a tailored distribution waterfall whereby proceeds are only received by a growth programme once a minimum hurdle rate has been met by pension funds.

Technical assistance facilities

As well as providing concessional finance, growth programmes can also provide technical assistance support to asset managers in the form of development of the investment pipeline, tools or resources to support day to day management or improving governance controls.

By seeking to create more investable UK assets for pension funds, the UK Government could also attract the attention of overseas institutional investors, such as the “Maple 8” public pension schemes in Canada, which already invest in large UK infrastructure projects.

There is no “one size fits all” model for structuring blended finance. To provide effective catalytic assistance, growth programmes will require not only a good understanding of each individual investment opportunity but also of the specific concerns which a pension fund may have on that investment’s risk-return profile.