East Riding moves deeper into niche alts in hunt for yield

Elusive high-yielding assets in the low-interest rate environment have seen many schemes seeking out more niche opportunities across a range of alternative assets.

In June Strathclyde Pension Fund approved more than £130m for alternative assets including wind farms and trade finance, while Falkirk Pension Scheme committed £30m to social housing through Hearthstone Investment’s Housing Fund for Scotland.

East Riding committed £80m to social housing across three different vehicles in December last year.

The criteria we look for is high income with downside risk protection but also the potential for capital uplift

Mark Lyon, East Riding Pension Fund

It also laid the groundwork to ramp up alternative investments in other areas with a £25m boost in commitments to aircraft leasing and an additional £40m to healthcare royalties.

The fund also increased its commitments to regulatory capital relief by £20m during the year, taking advantage of the fixed yields available for shorter-term financing deals with banks under capital requirement restrictions. 

Mark Lyon, head of investment at East Riding, said its first foray into social housing was part of wider theme in alternatives tracked over the past three or four years.

“The criteria we look for is high income with downside risk protection but also the potential for capital uplift,” said Lyon.

Strong income yield

Lyon said the main driver behind the fund’s entry into social housing was the guaranteed inflation-linked rental income, underpinned by a strong counterparty.

“It’s quasi-government risk but with an income yield that is significantly higher than you can get from index-linked bonds,” said Lyon.

“It’s the long-term nature as well, most of them are 20 to 25-year leases with inflation uplift and generally… the vacancy risk is assumed by the housing association, so we wouldn’t suffer if the housing was empty."

Lyon acknowledged the social benefits of this type of investment and said current supply and demand imbalances in the UK market would drive some additional security for the longer-term outlook within the asset class.

“We’re quite attracted to the fact that the demand for those properties is going to increase but the supply is a little bit restricted at the moment," he said. 

Lyon added that would provide the fund with "the visibility of income growth where it’s not just linked to inflation".

Social housing symmetry

Mark Davie, head of social housing investment at asset manager M&G, said investment in social housing provided opportunity for pension funds to create a “neat symmetry” with local authorities’ efforts to meet housing shortfalls.

Davie said strong regulation across the sector mitigated much of the risk for schemes due to the debt being fully collateralised.

“It’s not risk-free debt but it is low risk – no one has ever lost any money and the returns are better than the nearest thing to risk-free, which is gilts,” he said.

It’s not risk-free debt but it is low risk – no one has ever lost any money and the returns are better than the nearest thing to risk-free which is gilts

Mark Davie, M&G Investments

However, Davie identified a couple of “flies in the ointment” that could impact the sector following the latest Budget announcement.

“The housing bill, due to be published in the autumn, contains details of right to buy. [There] is a lot of detail that we still don’t know and that is causing some consternation,” he said.

Low correlation

Guy Hopgood, investment consultant and head of alternatives research at JLT Employee Benefits, said liquidity presented a major barrier for many schemes seeking to access alternatives, but that this was less of an issue for the Local Government Pension Scheme, which remains open to accrual.

Investors seeking to add alternatives to their portfolio will often be attracted by the asset class’s low correlation to wider markets, said Hopgood.

“That’s what people are looking for,” he said. “Certainly in terms of the aircraft leasing and healthcare royalties… there is very little correlation to general markets.”