Schemes pile into mortgage-backed income assets

Real estate debt investments – where a fund manager lends or refinances mortgages with scheme money, with the repayments creating scheme income – has become an additonal means of purchasing commercial property in an environment where bank credit is limited.

And lending to banks by institutional investors is increasingly taking the form of ‘covered bonds’, whereby banks’ mortgage books are put up as collateral against the bond, in case the issuer becomes insolvent.

Fixed income specialist asset manager M&G started direct mortgage lending in the second half of last year and has invested about £1bn so far.

The bulk of this is for its internal Prudential insurance funds, although it has a £285m real estate debt fund for third-party investors.

This invests mainly in so-called ‘junior’, or relatively high-risk mortgages, but demand from pension schemes is such that the firm is launching a ‘senior’ real estate debt fund later this year.

M&G head of real estate finance John Barakat claimed the asset class currently offers spreads of, on average, 300 basis points on comparably risky corporate bonds.

Meanwhile, according to French investment bank Natixis, pension funds are gaining on banks as the largest buyers of covered bonds in Europe this year.

Its research shows 22% of take-up of the asset class this year was by institutional investors, up from 12% in 2011, while the same figure for banks fell from 40% to 33%.

“UK activity has been driven by bigger banks’ refinancing of wholesale funding, leading to some large issuances,” said Laurence Ribot, Natixis’ head of covered bond syndication.

But he warned investors to investigate the quality of the mortgages underpinning the bonds and added there are likely to be fewer issuances in the second half of this year and 2013 than in 2011, as spreads have narrowed “significantly”.

Buyout provider Pension Corporation has moved around 8% of its £4.5bn portfolio into covered bonds over the past six months.

For a more detailed look at the growth of real estate debt investment among pensions schemes, look out for May's FT Pensions' Property & Infrastructure Specialist report, with Pensions Week.