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.
EE calculations based on Bloomberg data.
In the figure above we can notice that, over the last month, the asset betas of the materials and energy sectors have experienced a sharp increase, whilst the beta of the industrial has decreased. Such changes can be rationalised as indicating a re-pricing of risk for commodity driven sectors (i.e. sectors that benefit from rising commodity prices) and industrial sectors (i.e. sectors that benefit from falling commodity prices). More specifically, markets now perceive the former as riskier than the latter (whilst these sectors were perceived as equally risky in August).
Such re-pricing of risk might be due to the poor performance of commodities in September, after a rally recorded in the second half of August.