Lee Hollingworth, Head of UK Retirement, Franklin Templeton
Investment in private assets within workplace DC is the hot topic. So far, the debate seems to have gravitated towards the likely additional cost and the other barriers to entry with less focus on the “why?”. As with any investment decision, the key determining factor should be an improvement to member outcomes. Of course, the church of private assets is a broad one, from real estate to private equity. In this article I’ve chosen to focus on social infrastructure and consider the case for investment and within a DC scheme.
There are two widely-accepted reasons to invest in private markets. First, to access the so-called ‘illiquidity premium’: the extra returns available to investors who commit capital which they do not require back at short notice. The second reason is to access returns which are uncorrelated to other assets held in a portfolio, thereby seeking to smooth-out returns. Both make as much sense for a DC scheme member as they do for DB schemes, where members have long benefitted from the inclusion of private markets assets.
Additionally in the case of social infrastructure, there can be another benefit: a direct ‘impact return’ to communities and the planet. Our own research* showed that for “Generation DC” – pension savers aged 22-38 – there is a clear misalignment between what they feel about responsible investment and what their pension delivered on it. It also showed what a powerful motivator it could be for members:
- 78% say their current pension provision either doesn’t align with their own values (or they don’t know if it does)
- 45% would be motivated to increase their own contributions if their pension included responsible investment
- We estimated an additional £1.2bn of employee contributions could be invested annually by Generation DC if responsible investment was included in their pension.
We define social infrastructure as the physical property assets that facilitate social services, helping build strong communities. Assets include healthcare and education facilities, social and affordable housing, and buildings related to justice, emergency and civic services. Governments continue to account for the majority of investments in social infrastructure. However, the 2008 global financial crisis, the subsequent recession and then the pandemic led to cutbacks in government spending exacerbating the need for private capital.
From a pension investor perspective, social infrastructure has some interesting attributes:
- Stable cash flows and dividends – cash flows are determined by regulation or long-term contracts linked to the asset base rather than the economic cycle;
- Inflation hedge – the majority of the assets have a direct or indirect pass through of inflation;
- Diversification – low correlation to the economic cycle and therefore to equities and bonds that today make up the majority of a DC portfolio.
The lower correlation to other assets is driven by security on the income. In addition, the services provided by social infrastructure tenants’ businesses are often essential, making them less exposed to volatility. We saw this in the early months of the pandemic when social infrastructure-heavy sectors such as healthcare and residential property outperformed the likes of office and retail.
Doing well by doing good.
Franklin Templeton approaches social infrastructure as an impact investing strategy that is investing with the explicit intention of generating financial returns alongside measurable and positive social and environmental impact. It can be thought of as investing with a dual-return approach that seeks “win-win” investment opportunities where a measurable impact return is targeted in addition to an at-least market rate financial return. Asset renovations that directly improve the utility of the space for tenants and visitors can both improve the quality of services being provided and increase the value of the physical asset. Another example of a win-win opportunity involves making energy efficiency upgrades. These improvements can reduce service costs while reducing greenhouse gas emissions. Investing in social infrastructure with a focus on impact can not only yield market-rate returns, it can also create financial resiliency that improves financial results.
Therefore, in summary investing in social infrastructure offers two compelling benefits to DC schemes:
- It delivers attractive stable returns that are uncorrelated to listed equities and bonds and;
- it may lead to improved engagement among DC investors.
*The Power of Emotions. Responsible Investment as a Motivation for Generation DC, Franklin Templeton 2019.