Pension funds’ property portfolios are booming as real estate prices continue to march upwards. Property has been one of the best returning asset classes over the last five to 10 years for many funds. Access to diversified investments are also becoming easier, leading to ever stronger performance as funds increase their real estate allocations.
Dutch healthcare and social work sector pension fund, PGGM noted in its 2006 fourth-quarter report that property has been a major contributor to the recent good performance of the fund. It now invests 13.4 per cent of its funds in the asset class. Property was the best performing sector over five years for PGGM, returning an average of 15.2 per cent a year during that time.
For PGGM, as for many other funds, property has returned more than 10 per cent in every year since 1996, except one. That means it has also been less volatile than the fund’s two other largest invested assets, equities and fixed income.
Pieter Haasbroek, head of real estate Europe, PGGM, says: “Property has a substantial income yield component, which makes it attractive, particularly with the current low interest rates. Maturing pension funds favour income generating assets. Combined with the increasing transparency and data availability [in property investments], this will contribute to the allocation to property.”
So property is itself a good diversifier. But, as interest in it has risen, so has the importance of diversifying within properties, and of finding the right funds and advisers.
Swedish pension fund AP 3 recently appointed Aberdeen Property Investors Indirect Investment Management (API IIM) to build an Asian real estate portfolio. Aberdeen will advise the fund on the investment of €250m in around 10 different property funds over a period of four years.
This is API IIM’s second separate account mandate win from AP 3. In December 2006, Aberdeen was appointed to create a European property funds portfolio worth €250m for the pension scheme.
Bengt Hellstrom, head of alternative investments at AP 3, said that the fund also aims to create a similar structure for US property investments this year. This is part of a long-term diversification strategy which should result in international real estate accounting for about half of AP 3’s total property investments. Previously, the fund only used AP Property, the Swedish real estate company that invests domestically.
Mr Hellstrom said: “It is difficult to find an adviser that is good on a global basis. Aberdeen will do Europe [and Asia]. We have the option to do it in other regions with them but we are exploring and evaluating. Allocation to property will grow going forward for a lot of pension funds. This is due to basic diversification.”
Aberdeen runs several large property mandates for Nordic pension schemes. Anders Astrom, managing director at API IIM, said: “Six years ago you had to convince people about real estate as an asset class, and that it could be beneficial to go abroad as well. That is not the case today. Lots of people are increasing their allocation to real estate. Especially in Nordic regions, the real estate markets are too small and not diversified. Therefore, many schemes look abroad.”
With Dutch funds like PGGM diversifying geographically in property as long ago as 1995, why has it taken AP 3 this long? Indeed, AP 1’s property portfolio is still invested domestically - are Swedish funds particularly slow? Mr Astrom explained: “In the 1980s, Sweden had regulations forbidding international investments which Holland never did. When the Swedish regulations were removed, many people invested but they hit the wrong time in the market, so it became taboo. They are only just recovering from that. Sweden now needs one big investor to start the trend again. A lot of people expected Skandia to be the one, but it wasn’t. AP 3 is the one and I expect others to follow.”
Mike Samuel, chairman, Rank Group pension fund, gave a UK perspective. He says: “UK property has always been a good pension asset class because capital growth has been reliable over the long term. The rental stream is relatively high compared with dividends and tends to go up with inflation. Traditionally, it has been confined to commercial property – that is office, retail and industrial, rather than residential. It is particularly favoured by large pension funds which tend to invest directly rather than via a property fund.”
Mr Samuel said that a significant disadvantage in the UK has been the high “churn” cost, typically 7 per cent to buy and sell property, because of stamp duty. Therefore, it is only practical as a long-term investment.
Most UK pension funds set a domestic benchmark. So investment managers have not put too much in overseas property. He added: “I am not aware of funds starting to set international benchmarks for traditional property. But I am familiar with the trend into global infrastructure, which covers a much wider asset class - including airports, toll roads, utilities and government private finance initiative projects. A number of funds are making an allocation into this asset class, for example around 5-10 per cent, mainly as part of a wider strategy of diversifying their investment portfolio to lower risk.”
But consultants believe this is changing. Nick Duff, head of property at Hewitt, says that UK pension funds investing in property for the first time mainly choose pan-European real estate. He said: “Short to medium-term return prospects for Europe are more attractive than UK. Three more reasons are the sheer size of the European markets relative to their own, diversification and the search for high returns."
Investment in Europe has been made easier by the launch of a number of pooled vehicles. He said: “Now the pooled market is better than it was because there is more transparency and there are better managers around. You have more choice than you did five or 10 years ago.”
In the final quarter of last year, Hewitt completed three property fund of funds selections for major pension funds totalling £450m (€681m). It also advised two clients on strategies for extracting alpha from property investments.
Andrew Walker, senior investment consultant, Watson Wyatt, added: “Typically property was seen as a local asset in the UK and that was similar around Europe although the euro made it easier to diversify there. In the UK, it was expensive to invest in property abroad and there was possible tax leakage. But, as well as having more funds and better information now, some of the tax issues have been addressed. ”
See feature on booming property market on p35
