* Pension funds already invested in infrastructure
* Sector dominated by U.S., Canadian, Australian funds
* Revival of infrastructure bonds could fill gap
LONDON, Nov 28 (Reuters) - A government scheme to encourage pension funds to pay for new roads, hospitals and schools could fall short of its targets, despite the inherent appeal of such inflation-friendly investments.
The plan, to be unveiled in full on Tuesday as part of Britain's autumn budget statement, is aimed at enticing 20 billion pounds ($30.97 billion) of investment in infrastructure from pension funds and insurers, Treasury minister Danny Alexander said on Monday.
The influx of private sector cash would help generate economic growth by upgrading transport and communication networks while offsetting the impact of public spending cuts designed to rein in Britain's budget deficit.
Pension funds and insurers say they are in principle keen to invest in such projects as they generate long-term cashflows that can be used to fund payments to their customers, often at attractive rates of return and with low default risk.
"Infrastructure holds a lot of appeal because of the highly regulated nature of the investment and the fact that there is often some kind of implicit government support," said Georg Grodzki, head of credit research at asset manager Legal & General Investment Management.
"(The government plan) could have a big signalling effect that something serious is about to change, that a new institution is being created which will lead to interesting developments."
However, the scheme could struggle to generate the desired level of investment as the pension industry's appetite for infrastructure assets is satisfied by specialist fund managers offering indirect exposure to the sector.
"Infrastructure debt is a complex investment category reserved for highly sophisticated institutional investors," said Nicolas J. Firzli, co-chair of the World Pensions and Investment Forum.
"At this stage, most UK pensions wishing to gain a degree of exposure to infrastructure debt or equity have done so indirectly."
Private investment in infrastructure worldwide is dominated by giant Canadian, Australian and U.S. pension funds that have built up unrivalled expertise in the sector from decades of financing such projects in their home countries.
They also manage sizeable infrastructure investments on behalf of other investors, including British pension funds, who are attracted by the returns on offer, but lack the required in-house skills.
One option for drumming up greater financial support from the private sector would be to revive the infrastructure bond market.
This would involve pooling projects together and financing them through sales of interest-paying debt securities, possibly backed by some form of state guarantee, and could attract strong interest from insurers.
"The bond markets are a huge untapped source of finance and insurers have long been keen to channel more of the investments they manage into UK projects to help the economy fight its way back to growth," said Otto Thoresen, Director General of the Association of British Insurers, whose members manage investments worth 1.7 trillion pounds.
British infrastructure bonds were regularly issued in the first half of the last decade by private contractors hired to build schools and hospitals under Britain's Private Finance Initiative.
But they have not been sold in any volume since the 2008 financial crisis, partly because the withdrawal from the market of specialist "monoline" bond insurers has made it impossible for such securities to win an ultra-secure triple-A credit rating.
The government could remedy this by offering to backstop potential losses on infrastructure bonds, boosting their credit rating and making them palatable to a wider range of investors.
The government could also have a role in packaging together comparable small-scale infrastructure programmes to create combined projects worth more than 250 million pounds, seen as the minimum threshold for a viable bond issue.
However, the investment appeal of infrastructure bonds would be tempered by Europe's new Solvency II capital rules for insurers, which look set to increase the capital charge on infrastructure assets when they come into force in January 2014.
L&G's Grodzki added that insurers and pension funds should in principle be able to identify and invest in attractive infrastructure projects without government help.
"If we're talking about viable, interesting projects where the risk return profile is investable, it shouldn't really be necessary," he said.
"That's why we have the City, which makes a living out of putting transactions together and earning a fee in the process."