Efforts to increase UK social infrastructure investment in 2024 require more detail from the government and more knowledge among investors.
The UK faces a significant underspend across education, housing and healthcare, which could leave society and individual citizens “unsafe” and vulnerable to “extremely worrying” disparities in health and wellbeing.
These are the views of think tanks and trade associations including the British Medical Association (BMA), which says the National Health Service’s (NHS) £190.1 billion budget for 2024/25 “is not enough to keep up with demand”, despite rising £0.3 billion over the previous year.
The BMA highlights lack of infrastructure investment, noting “there are not enough beds in hospitals and some estates are unsafe”.
In education, The Institute for Fiscal Studies (IFS) reports that by 2024−25, after accounting for the specific costs, “school spending per pupil will still be 3% lower than in 2010”.
These cuts are “extremely worrying” to the Education Policy Institute which argues they will widen gaps between the poorest children and their peers.
Housing has garnered headline-grabbing promises of a £14 billion government grant to build 145,000 affordable homes each year, estimated to cost £35 billion annually.
But this represents a £20 billion gap in addition to financing needed to ensure current homes meet new safety and environmental standards.
Obvious source of finance
The UK government is well aware of the need to encourage private sector investment across social infrastructure if it is to have any hope of meeting its levelling-up agenda; promises to cut NHS waiting lists; and honour a commitment to deliver “world-class education, training and care”.
Institutional investors – specifically pension funds – are an obvious source of financial support since they have long-term liabilities with terms that match likely return streams, also aligning with a need to make a positive ESG impact.
Mark Gross, Head of Development Capital at investment manager Downing, says: “Social infrastructure by its nature has a social impact, which contributes to the drive for a more sustainable approach to investment. The rewards can be attractive for society and investors alike – a win-win scenario.”
Yet investing in schools, hospitals and housing is far from straightforward, presenting liquidity constraints and typically demanding large amounts of capital which may stretch many trustees’ limits.
The industry has long circumvented these challenges by offering access to assets through broader real estate funds.
However, Stuart Hanson, Associate Director, Client Solutions at AlphaReal, says that while specialist managers have been investing in the housing, healthcare and educational sectors for decades, “many institutional investors and their consultants have been historically most comfortable with housing, allocating less capital to the other sectors within social infrastructure”.
Hanson says this picture has changed in the last year, driven by the Local Government Pension Scheme (LGPS) sector, which has shown a burgeoning appetite for social impact funds.
AlphaReal research found that 87% of LGPS pension professionals expect their funds to focus more on “generating a positive social impact”. Of those, more than three-quarters (77%) will concentrate their social infrastructure allocations on the UK only.
But with government under such financing pressures, it cannot afford to miss out on the billions of pounds available from UK pension funds outside of the LGPS.
This was made evident in the Mansion House reforms announced by Chancellor Jeremy Hunt last July, intended to “unlock capital for our most promising industries and increase returns for savers, supporting growth across the wider economy”, ultimately driving capital to private markets which includes, but is clearly not limited to, social infrastructure assets.
In particular the emphasis is on making it easier for defined contribution (DC) schemes to allocate to illiquid asset classes.
Mike Toft, Head of Care Homes at Octopus Real Estate, supports the proposals, but says they must clarify how pension funds can align their investment strategies with the socially-positive outcomes sought by the government and thus define acceptable assets to DC investors. “The devil will be in the detail but anything that helps illiquid assets to reach that [pensions] market is positive.”
The missing detail is an issue for Joe Condy, investment consultant at Quantum Advisory, who argues that “for a large majority of pension schemes, we don’t think [the Mansion House reforms] will make a huge difference”.
“By their nature, social infrastructure investments are illiquid and are therefore subject to the typical barriers to entry. Granted, some of the larger schemes with higher governance budgets and flexibility might be more incentivised by the reforms for various reasons,” he says.
“But for small- to medium-sized schemes we think accessibility is still an issue, and access these types of investments might be better achieved through investing in diversified real estate or multi-asset private market funds instead, where concentration risk is managed more effectively.”
Condy says that while the development and launch of long-term asset funds, which make it easier for individual investors to allocate to illiquid assets, may encourage DC schemes towards social infrastructure, he adds “we don’t foresee a big or rapid take up across the industry”.
The Pensions and Lifetime Savings Association (PLSA) has welcomed a government commitment not to ‘strong-arm’ schemes into investment strategies that are not in members’ best interests, making clear “it is essential to preserve the right of pension funds to invest in line with their fiduciary duty”.
But the association, which was also involved in the design of UK long-term asset funds, as well as the Bank of England’s Productive Finance Working Group, also wants more detail.
Tiffany Tsang, Head of DB, LGPS & Investment at the PLSA, wants to know how far the government is willing to go in supporting their own proposals. “It’s about making sure that there is a pipeline of opportunities,” she says. “While social housing is quite well understood, healthcare and education – which obviously contribute to overall wellbeing in local communities – need to be thought through more so the government can come through on their promises.”
The AlphaReal survey reveals a lack of investment opportunities as the second biggest barrier to LGPS professionals investing in social infrastructure after a lack of knowledge of the investment impact and characteristics.
AlphaReal’s Hanson estimates the UK’s shortage of fit-for-purpose social infrastructure stock at more than £50 billion, which “represents a significant investment opportunity for institutional investors” in elderly and specialist care, supported living and primary care.
If the Mansion House reforms are successful in encouraging investment in small and medium-sized enterprises (SMEs) and start-ups, says Jack Burnham, Head of Affordable Housing at Octopus Real Estate, these may provide innovations to support growth in social infrastructure sector, creating a virtuous circle where more impactful opportunities arise offering long-term returns to investors.
“If the reforms can power SMEs to deliver the technology, potential offsite manufacture and other innovations that can speed up construction, that can only be a good thing,” Burnham says.
Despite abundant potential, social infrastructure is not without a two-pronged risk: a failure to meet both return and impact objectives.
Toft says that investing in a well-researched, high-quality operation that is fit for purpose should result in a profitable business that delivers on its societal contract.
Yet there have been more than a handful of horror stories across the social sector where disreputable firms have gone bust leaving some of the most vulnerable in society high and dry, and investors out of pocket.
Hanson says: “The main non-financial risk is reputational risk, in the event that assets are mismanaged and don’t provide the positive social impact that was envisioned. Operator selection is therefore an incredibly important component of this asset class and why investors look to specialist managers to help manage this risk.”
He continues: “It’s worth highlighting that most investors will invest through a fund that is the legal owner of the assets, which provides an additional layer of protection to the end-investor. As part of the investment process, establishing and evaluating the social benefit you are targeting is key; additionally, you can work with third parties to assess and review this.”
As a sector, social infrastructure is poorly researched and understood, says Gross at Downing, adding: “Promoting further research, responsible journalism and educating the public on the benefits of private investment in social infrastructure – including the capability to deliver high-quality, efficiently-run services where the needs of society are properly met at a fair price to the public – is critical.”
Gross goes as far as to say the UK needs “to quickly move away from the distorted belief that private capital should not make a profit from businesses that serve a critical social benefit. The perception of a win-lose relationship between the providers of private capital and the public is unhelpful and inaccurate”.
In November’s Autumn Statement, Chancellor Hunt confirmed a £320 million budget to implement the Mansion House reforms to deliver “a raft of measures – which are expected to provide an extra £1,000 for people’s pension pots every year – [and] will help pension funds invest in high growth, innovative companies to deliver for savers and grow the economy”.
Investing in social infrastructure can be a win/win for investors and society, but widespread allocations to the sector could still be challenging for all but the largest investors, at least until there is a greater understanding of what is involved.
As Condy says: “For the large majority of trustees, [social infrastructure] is a fairly specialist area where understanding and research is limited. Trustees therefore rely on their advisors, where the potential benefits and access points are becoming more well understood, but it still remains a niche area for most pension schemes.”