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Friday, October 30th, 2015

Return on infrastructure assets vs. equity
posted by Europe Economics

At the UK governing Conservative Party’s annual conference on October 5th, Chancellor George Osborne announced that 89 of the UK’s local government pension schemes (LGPS) would be consolidated into six new “British wealth funds”.

At present only around 0.5 per cent of £180bn in LGPS assets are in infrastructure, or around £2bn. The government believes that this is partly because LGPS are too small to invest properly in infrastructure.  It notes that in countries with larger pooled public pension schemes, typical infrastructure investment is around 8 per cent — or around £14½bn, some £12½bn more than at present.

The following table shows recent determinations of the allowed return on capital for infrastructure assets by European regulators.  If the newly created British wealth funds were to move their capital into infrastructure, they will need to move them out of some existing investments. It is likely that they would need to sell some of their current equity to invest in infrastructure. If they want to keep the same overall portfolio return they would need to move some other funds into riskier equity since allowed returns on capital are lower than returns on equity, as illustrated indicatively in the table below. 

Table 1: Recent determination of the cost of capital for infrastructure

Source: regulators’ websites.
Note: return on capital showed in the tables are set on the basis of different assumptions (e.g. pre/post-tax) and should thus not be compared across countries. In jurisdictions where the return on capital is set on a pre-tax basis, the overall pre-tax weighted cost of capital may be smaller than the post-tax return on equity showed in the table.