As Thames Water Utilities Ltd. came under fire this month for its financial mismanagement and poor environmental record, the debacle highlights institutional investors’ responsibilities around due diligence and risk management.
“Thames Water should act as a kind of warning,” says Andrew Clare, a professor and chair in asset management at the City, University of London’s Bayes Business School. “Thames Water . . . loaded themselves up with debt and interest when interest rates went up and their business model no longer worked.
“It’s a story about poor risk management on the part of the pension funds that were invested in [Thames Water]. They never asked themselves deeply, . . . ‘If we ever did any kind of scenario analysis, what does their business model look like if interest rates rise to five or six per cent?’ And if they’d done that, I think they would have been a little bit more cautious.”
A shareholder funding update published by Britain’s largest water and wastewater company last week said the shareholders — which include the B.C. Investment Management Corp., the China Investment Corp., the U.K.’s Universities Superannuation Scheme and the Ontario Municipal Employees’ Retirement System — have agreed to provide a further £750 million of equity funding into the company to “further improve operational performance and financial resilience.”
“Our shareholders have consistently been very supportive of Thames Water by approving investment in the business over and above regulatory allowances, foregoing any income since 2017 and investing £500 million of new equity funding in March 2023,” said Ian Marchant, the company’s chairman, in the update. “The additional investment announced today is the largest equity support package ever seen in the U.K. water sector and underscores our shareholders’ commitment to delivering Thames’ turnaround and life’s essential service for the benefit of our customers, communities and the environment.”
The OMERS’ infrastructure arm initially invested in Kemble Water Holdings Ltd., its holding company, in March 2017 as part of a consortium of other investors. The pension fund then boosted its holdings by 4.4 per cent in December 2017 and by another four per cent in 2018. When that transaction closed, the OMERS had about a 32 per cent interest in the utility company.
While the BCI and the OMERS both declined Benefits Canada‘s request for a comment, the Universities Superannuation Scheme released a statement that said, in part: “As envisaged in June 2022, Thames Water received the expected £500 million of new funding from its shareholders in March 2023 and is continuing to work constructively with its shareholders in relation to the further equity funding expected to be required to support Thames Water’s turnaround and investment plans. . . . Thames Water remains focused on delivering for its customers, the environment and stakeholders.”
The investment is part of a wider trend by large pension funds and other institutional investors to look globally for infrastructure investments. On this side of the pond, the Canada Pension Plan Investment Board, alongside the Ontario Teachers’ Pension Plan and the Public Sector Pension Investment Board, joined a group of investors in November 2022 to back new infrastructure funds introduced by the Indian government. The Ontario Teachers’ and PSP Investments were also part of a consortium that bought an Australian infrastructure investment company in August 2021.
In one of Clare’s previous roles, he worked at a mid-sized pension plan with assets just over £3 billion. The mid-sized pension plan sponsor made investments in infrastructure through a diversified pool offered by an investment manager. “We were taking small stakes in a large number of infrastructure product projects, but that was our choice.”
He believes the fund management industry has done a good job creating different types of vehicles for investing in infrastructure, but he cautions any pension plan sponsor investing in these products to be wary of the experience of any fund manager.
Ultimately, investments in infrastructure are just things that produce a cash flow, says Clare, suggesting investors do as much due diligence in the security of that cash flow as they would in an equity stock like Apple Inc. or Microsoft Corp.
“So you need to understand the nature of that cash flow — and the risks around that — just as much as you would anywhere else. All pension funds have to generate some cash flow into the future to pay their members, so you need to look at it through the same lens and use the same sort of analytical techniques to work out how they fit in to your portfolio overall.”