BMA hunts for yield with long-lease property

Many pension schemes sought respite from equity market volatility and low bond yields in alternative assets over 2015, according to analysis by Financial Times service MandateWire.

In Europe, institutional investors poured £18.1bn into property investments during the year, as low interest rates and market uncertainty made for a bleak outlook in traditional assets. 

But well ahead of the recent market rout, the £320m BMA pension scheme opted to diversify its lower-risk assets away from corporate bonds and gilts.

We know we’ve got a steady income stream coming in and we know in terms of total return from the fund that is likely to grow

John Keeling, BMA pension scheme

In 2007 the scheme allocated 11 per cent of assets to long-lease property and has continued to top up capital to keep its strategic target since then.

John Keeling, chair of trustees for the BMA scheme, said the strategy provided access to long-term, secure income streams with built-in inflation protection.

“They’re all high-quality properties with very long leases, something over 30 years,” he said.

“The leases are set to either match inflation or are leased with a fixed uplift which is built into the contract with the tenant, so we know as an investor that we’ve got an increasing stream of income coming back to the pension scheme to meet our future liabilities.”

The BMA scheme opts to draw down income generated by the fund on a quarterly basis, and Keeling said the predictability of income and inflation protection offered through the structure allows for a “smoother ride” through the property cycles.

“We know we’ve got a steady income stream coming in and we know in terms of total return from the fund that is likely to grow,” he said.

Long-term cash flow

Ben Jones, head of real estate income at M&G Investments, said long-lease property provides schemes with long-dated, contracted cash flows to meet liabilities alongside a degree of inflation protection.

“Because of those long-term cash flow streams, the volatility around the values of those assets tends to be reduced versus shorter-dated real estate and other assets,” he said.  

“In the current environment where you’ve got very low interest rate[s]... finding assets to produce some form of yield and produce regular cash flows to pay pensions is probably a major priority.”

Contractual uplifts

Nick Ridgway, head of investment research at consultancy Xerox HR Services, said contractual uplifts are typically structured either on a fixed annual or five-year basis, or pegged to the retail or consumer price index with accompanying caps and floors. 

“Rental growth will not fall in a deflationary environment,” he said.  

“You get a degree of inflation linkage from these assets which can give you an alternative return profile, a helpful match for liabilities, which are either uplifted on a fixed basis or by inflation.”

More broadly across the asset class, Ridgway said the outlook for property may not be as consistent over the next five years after stellar returns in 2014 and 2015 and said investors must be targeted in their approach.

“If you are looking for something that is a partial liability match, then long-lease property is potentially more attractive,” he said.

“If looking for some growth from capital value appreciation, then core property and potentially high-yielding property could offer some value, but that doesn’t come without some stock-specific risk now.”