As BAE Systems weighs up a merger with EADS, the defence company’s UK scheme has identified reasons why its property investments produced disappointing results over the past year
In its annual report, the BAE scheme said the property market in general had performed well over the year but its own investments had suffered.
Last year, the annual capital values for prime UK property rose by 3.8 per cent while less expensive properties declined by 3.6 per cent, according to IPD, the property research specialist.
The largest annual decline in capital value for the UK and European property markets was in 2008 when they fell by 26.3 per cent and 9.3 per cent respectively.
The fallout from the financial crisis continued for longer in the US. The steepest annual declines happened in 2009 when the indices declined by 23.7 per cent.
David Adam, the scheme’s chief investment officer, said this was due to some exposure to poorly performing office and industrial units, as well as from a lack of owning London office assets.
The proportion of BAE's assets invested in property is more than double the average rate of other UK schemes.
Property is a popular pension investment because it provides diversification from equities and bonds. In addition, it offers both capital growth and income.
But the pension industry's affection for the property sector was tested during the financial crisis where there was a peak-to-trough fall in UK property values of 44 per cent.
Schemes that are able to identify and invest in assets that provide long-term, inflation-linked returns will be in a stronger position to pay their members’ retirement income.
BAE’s property portfolio
The BAE scheme has 7.4 per cent of its assets invested in property. As a proportion, this is down from 7.7 per cent of the total portfolio in 2011.
London has attracted a lot of flight capital from countries, including Greece and Russia
“The funding level… has been a major focal point in recent years,” said Adam in the annual report.
“This has resulted in the scheme adopting a risk reduction, or derisking, strategy directed at moving investments into assets that more closely match the scheme’s underlying liabilities.”
Of the scheme’s £9.5bn assets, £662m is invested directly in property. UK schemes have an average 3 per cent allocation to direct property investments, according to Mercer.
There are a number of ways of investing in property. For large enough pension schemes, building a bespoke property portfolio is possible.
But many pension schemes have insufficient assets to build a diversified portfolio. For smaller and medium-sized schemes, there is the option of investing in a pooled fund.
There are two types of pooled fund:
A direct fund builds up a pot of capital and then typically uses this capital to invest in a specific type of asset class, for example, prime offices.
The other type of pooled fund invests in property company shares rather than buying buildings.
A wholesale fund gives a pension scheme direct and unbiased access to property returns.
But it can often take a long time to invest the capital because the assets have to be accumulated and then the buildings have to be bought.
The charges are also steep. It costs around 1 per cent in stamp duties and legal fees to buy property.
It can also be difficult to have a truly diversified portfolio as that would require investing in multiple funds around the globe.
Best-performing assets
The widely held view of the UK being a safe haven for real assets has resulted in strong performance of the London property market.
Since the financial crisis, the global property securities indices have shown double-digit returns
Paul Richards, European head of Mercer’s real estate boutique, said: “London has attracted a lot of flight capital from countries, including Greece and Russia.
“These types of investors are most comfortable buying trophy assets such as central London offices.”
But other property specialists think London is benefiting from a more sustainable trend.
Simon Hedger, head of real estate at Principal Global Investors, said: “Since the financial crisis, the global property securities indices have shown double-digit returns.
“That performance has been led by the world’s financial centres, which include London.”
There has been a very large split in the property market in recent years. “It’s very much a chalk-and-cheese market,” said Hedger.
“Prime assets have performed well, while secondary and tertiary have significantly underperformed because the banks are simply not lending to lower quality assets.”
Schemes that do not own a high proportion of UK prime property and are underexposured to the London office market could experience underperformance in their portfolio. BAE Systems Pension Scheme declined to comment.
