Now is the time to invest in infrastructure
10 Nov 2015
Our CEO's speech at the FT Infrastructure Conference, 10 November 2015
Good Morning, and thank you for inviting me today.
I like to think that Legal & General is an “infrastructure disruptor” – we are active first movers in building institutional infrastructure investment in the UK – a perspective I’m very happy to share.
This is a hugely exciting time for infrastructure investment, for several reasons:
- First, it is economically vital: a view which we were at one time almost alone in arguing, but which is now becoming mainstream.
- Second, devolution has driven a switch in ambition as local politicians are finally stepping up… recognising our towns and cities are not overbuilt they are under demolished and we have created an inter-generationally unfair society.
- Third, this switch in attitude is happening more broadly as people move from NIMBY to PIMBY: Not In My Back Yard to Please In My Back Yard.
- Fourth, there is a wall of institutional money available including local pension funds but also global funds - the UK is a great place to invest
- And fifth, technology is accelerating: we can, if we make the right choices, build efficient low cost infrastructure in all sectors - housing education energy transport and healthcareOne of our main drivers at Legal & General is to do business which not only adds value for our customers and shareholders, but which is also economically and socially useful. Infrastructure investment fits squarely into that category, and this is an exciting time to be engaged as an infrastructure investor.
Infrastructure investment is also something that fits very well with our particular business model. We invest as a principal, through our Legal & General Capital business, which invests our own balance sheet and has made £6.5bn of direct investments in the last couple of years. We also invest as principal through Legal & General Retirement, which manages our £45bn annuity book and makes long-dated investments in assets to match long-dated, highly predictable liabilities. And thirdly we also invest as an agent, through Legal & General Investment Management, which has a £17bn property and real asset business.
These three investment strands are synergistic: they share expertise, and they work together both to create and structure assets, and to manage them. One of our ambitions is to create new asset classes in the broadly-defined infrastructure sector – to match our own investment needs, and then to create opportunities for LGIM’s broader client-base of over 3,000 pension and sovereign wealth funds.
It is when these different components within L&G spark off one another that we see real opportunities… to enhance risk-adjusted returns, but also to drive growth in the broader economy, in jobs and productivity, through large-scale regeneration and infrastructure upgrades to the UK’s regions and cities.
Our scale – we have £48bn in annuity assets and over £700bn in assets under management – and our structure mean we are particularly well-suited to infrastructure investment. The Towers Watson ranking of global institutional investors published last week includes five UK insurance companies in the top 50, as well as other EU players such as Allianz and Axa.
Historically, the search for long duration has driven L&G to invest in the US corporate bond market – perhaps the only place with a bond market deep enough to deliver both long maturities and suitable investment-grade ratings. Of course, because our liabilities are sterling, there is a currency mismatch and hence a frictional cost – so we are now looking to move investments back into the UK and into real assets. Our annuity book is £48bn – we believe we can gradually repatriate £15bn from foreign bonds and into UK real assets – structuring and creating those assets as required.
Moreover, with long-dated liabilities – ours go out to 30, 40 or even 50 years – there is opportunity to step into space at the long end where banks have been retrenching. The advantage for an institution like L&G is that there is no need for maturity transformation and there is typically a set of liabilities to match most asset profiles – index-linked, for example, or index-linked with a cap and a floor.
Student accommodation is a good example. Our programme of investment in this asset category now amounts to £1.25bn and funds 12,000 beds. The longest dated investment is 50 years, the shortest 28 years. The investments are structured to enable universities to levy predictable rents and match our own liabilities… and provide good security in the event of default: in the unlikely event that Imperial College goes down, we own a valuable block of 500 small flats in central London.
The developed West has been underinvesting in infrastructure, but borrowing and over-consuming instead. We have outsourced infrastructure investment to Asia, and we need to reverse this structural mis-alignment.
It is now acknowledged that this is a trend which has to be reversed: physical and digital infrastructure has to be upgraded if we are to get away from the cycle of low productivity and low wages. It is the right approach for example to tackling a major problem in the UK – the widening gap between the economy in London and in our other cities.
One of the effects of QE and ultra-low interest rates following the global financial crisis was to drive up the prices of existing traded assets. An obvious response is to look to illiquid assets where the risk-adjusted returns include some enhancement for illiquidity. If, like L&G, you have known liabilities, you can structure or create the right assets for your book – these will undoubtedly include infrastructure and property.
Another reason why we find infrastructure so interesting is the very clear connection to the real economy. Markets for traded securities seem to focus almost entirely on Fed-watching or trying to interpret every nuance of central bankers’ comments. A self-referencing market watches central banks and tries to anticipate a move… the central banks watch the markets to see how they might react… the market watches the central banks watching the market and so on.
All this activity focuses on “little i” or interest rates, and ignores the much bigger issue of “Big I” investment. Over thirty or more years, the West focused on consumption, and infrastructure investment was outsourced to Asia, along with manufacturing.
One part of the UK government’s response is its National Infrastructure Plan: the 2014 edition encompasses a total pipeline of £466bn, with £277bn in construction. The majority of this is in energy and transport.
But progress is not fast enough. One way to speed up is through the Infrastructure Commission which George Osborne has set up under Andrew Adonis. This should enable the government to take on board some of the recommendations that Sir John Armitt developed – ironically for the opposition – before the election.
The availability of large institutional funds – in many cases ideally suited to long-term investment in relatively illiquid or non-traded asset classes – is something that governments are becoming increasingly aware of. This is true at a national level, but also at an EU-wide level.
This level of political support is hugely encouraging. You can see it running through Jean-Claude Juncker’s Euro 315bn plan to increase investment in the EU, and it is even more obvious in the Capital Markets Union exercise that is being headed by Commissioners Kattainen and Hill.
Their mission is to enable the EU’s long-term savings to be more effectively invested in asset classes that drive real growth and jobs – including infrastructure… You saw from the map what Legal & General has started to do in the UK... I’m sure EU institutions would like to add Lille to Leeds and Krakow to Cardiff.
There is a strong practical element to match the rhetoric: one of the first CMU initiatives that Jonathan Hill has undertaken has been to adjust the definition of infrastructure for insurance firms using the Solvency 2 Standard Model so as to facilitate more investment: this is just the start.
An important factor which is a positive driver for infrastructure investment in the UK is the government’s focus on increasing productivity by devolving financial decision-making to regions and cities. We are strong supporters of regional and city devolution and of the “Northern Powerhouse”.
Historical under-investment in the UK outside London means the multiplier effect of infrastructure investment in city regions is very significant: for physical infrastructure it is estimated £2.50-£3.00 of economic activity for every £1 spent, and the higher multiplier of digital investment: every £1 invested in broadband generates an estimated £20 for the economy.
Both Ken Livingstone and then Boris Johnson demonstrated the value to the London economy of having an empowered mayor – the same is happening in Manchester, it happens already in Cardiff under the leadership of the Welsh Assembly Government, and will spread to our other cities including Leeds, Sheffield, and “the North of the North” including Newcastle.
It is a catalyst for action. We have a good record of investment in city regeneration acting as an agent and as a principal: for example our English Cities Fund has been active in Salford, Wakefield, Liverpool, Canning Town and Plymouth… all examples of places are not over-built, but under-demolished.
In Bracknell we are rebuilding the town centre and providing an additional 1,000 homes. And in Salford is a really good example where enlightened local political leadership is delivering massive transformation and where the BBC’s relocation to Media City is fundamentally changing a previously depressed area.
L&G’s structure means we are can also invest in partnership with our institutional clients. We have two such partnerships – around £700m – with the Dutch pension fund PGGM – and also as a principal. We bring these components together under our RIO funding vehicle which was launched earlier this year.
RIO is the UK government’s Regeneration Investment Organisation, and is responsible for matching international investment to UK infrastructure projects. Our role alongside RIO is to act as the UK investor. Importantly, this includes both asset management and principal investment – we have “skin in the game” which achieves a high level of economic alignment above and beyond fund management. Our RIO funding vehicle is intended to provide £15bn if investment in regeneration: £1.5bn or 10% from L&G and the remainder from partners who can select which projects they want to co-invest in.
To date we have made two RIO investments – a £162m investment to regenerate North East Leeds, and an investment in a £450m project to regenerate central Cardiff. There are more deals in progress.
As a private sector investor, we have views on how the Plan can be best delivered with the private sector working alongside and in partnership with government. They can be summed-up under the heading of economic viability.
Localism and devolution applies even more obviously to urban regeneration and housing. We see housing as a real asset category and part of broader infrastructure investment. The economics again makes sense on a standalone basis: as an investor it ticks our boxes at L&G.
Britain is chronically short of housing across all forms of tenure: and in the last two years, L&G has created a pipeline of some 25,000 homes which we are either building or financing. Having started with student accommodation, we are diversifying into accommodation for older people, as well as build-to-sell through CALA Homes and most recently, build-to rent, again in partnership with PGGM.
Economic and social infrastructure goes alongside housing in our regeneration projects. Bracknell, where we are in a JV with Schroders to redevelop the town centre, is a great example where localism has helped generate innovative solutions to previously intractable problems. In that case it was securing planning for 1,000 homes on Green Belt land nearby in Crowthorne. This is not Green Belt as we think of it – it is brownfield in the Greenbelt – a former bus testing track.
Funding road upgrades is another such area: the government nationally has shied away from Road Pricing: local solutions can be found as part of broader development: we are working on some right now.
Still looking at transport, two of the biggest projects, HS2 is not an infrastructure project that we would choose to invest in.
The HS2 rail link is addressing inter-city connection between London, Birmingham and by the mid 2030’s, Manchester. The more urgent focus needs to be on connectivity within cities and regions. Project sizes are more manageable, delivery is quicker, and the local economic impact much greater. I would therefore give a higher priority to “HS3” or the “Crossrail of the North” improving connectivity between Liverpool, Manchester, Sheffield and Leeds rather than the Birmingham-London line.
Similarly, I would focus on smaller projects that free-up rail and road bottlenecks: a good example adjacent to our Salford project is the short stretch of track known as the Ordsall Chord – a small investment giving a big uplift in rail capacity in and out of Manchester.
Hinkley Point is also a project that needs to be looked at through the lens of economic viability. The cost, at £25bn, is very high, but the real problem is the cost of the electricity: £92.50 per MegaWatt Hour, index linked, against a current wholesale price of around £40. This simply cannot be good value: I can think of no industry where contracts are awarded to supply goods or services at twice the market rate, rising with inflation, without customer outcry.
Our approach to the energy sector is rather different. We are increasing our focus on clean energy – in particular solar and wind - for two reasons. First, because the pace of technological change – both in generation and storage - is such that we see the equivalent of Moore’s Law in computing starting to take hold, with the price of clean energy coming down, and the capacity rising. We support Amber Rudd’s and the government’s approach to the removal of subsidies. The key test for investment is whether it is economically viable on a standalone basis – relying on a subsidy regime creates too much political risk, especially for a very long-term investor like L&G.
We will see radical change coming in the energy sector. Alongside clean energy capture and storage, we will see a shift in the balance between national and international grids, networks and interconnectors and local town or city-sized solutions – effectively going off-grid. The localism agenda will be as big a part of this debate as the technological debate being driven by the likes of the Apollo project.
So the future is exciting for infrastructure investment by long-term institutions such as L&G. We are hopefully entering a new phase of “constructive collaboration” with government: another proof point here is the intention, announced by George Osborne at his party Conference last month, to ensure some Local Government Pension Assets are allocated to the infrastructure space as part of the reform of LGPS.
The traditional complaints about public policy and infrastructure are less applicable than they were: planning is getting easier… there is an effort to address the tortuous rules around public procurement… and the localism agenda means we are no longer just faced with huge centrally-driven projects that are more about politics than economics.
I will finish by returning to the theme of social and economic usefulness. We live in an age of greater individual responsibility – including for long-term saving and pension provision. Yet many people remain disengaged from their personal finances. Infrastructure investment offers a way to re-engage them and to deliver a very obvious social benefit.
I’d like to see a future where someone, for example living in Salford and working in Manchester can see very clearly how their pension contribution is being put to work to improve transport links for their commute, to improve housing stock for their children, and to create a world-class infrastructure that will attract firms and jobs keep those children in employment…. and all this while creating a secure future in retirement. I don’t see this as a pipe-dream – it is something which it is our task to deliver.
Thank you very much – I’m now happy to take questions.