(May 31, 2012) — The largest corporate pension fund in the United Kingdom has bought a stake in a domestic water company as an inflation-linked investment for its long-term liabilities.
The BT Pension Scheme (BTPS), which has around £33 billion in assets, has bought a minority stake in Thames Water, the largest utilities company of this type in the UK, the fund announced this week.
Frank Naylor, Head of Strategy for BTPS Management, commented: “The investment in Thames Water clearly demonstrates BTPS’s on-going commitment to investing in domestic infrastructure. Thames Water is a well-established business governed by a mature, transparent regulatory regime that should provide predictable inflation linked cash flows over the long term.”
The majority of the members of BTPS are based in the UK; therefore its liabilities are mainly linked to UK inflation. Returns from this investment should act as a natural hedge for this risk.
Rob Gardner, Co-Chief Executive of consulting firm Redington, said pension schemes were well positioned to capture the illiquidity premium in infrastructure assets such as water companies as they provided capital in return for long-dated, secure inflation-linked cash flows.
“Water companies are attractive as they are regulated by Ofwat [UK water company regulator] and their pricing mechanism maybe increased in line with an agreed price review, based on a formula related to the retail price index (RPI). Thames Water is permitted to earn a secure inflation linked return on its regulatory capital value (RAV). This is why UK Water is an ideal asset for a pension scheme looking for secure long-dated inflation linked cash flows with a significant return over long dated inflation linked gilts.”
Inflation in the UK actually fell for the first time in almost a year last month, but it remains a concern for pension funds whose liabilities can rocket with any increases. In the first quarter of the year pension funds carried out record levels of inflation hedging, F&C Investments reported this month.
Across Europe inflation concerns are also evident. Consulting firm Mercer said 15.1% of European schemes and 24.8% of UK schemes were planning to increase allocations to inflation-linked bonds over the next year.
Phil Edwards, Principal in Mercer’s Investments business, said: “Given the extent of central bank monetary easing in the developed world in response to the financial crisis, many investors remain concerned about the potential for inflation to emerge in the years ahead.”