Circling vultures get mixed reception from consultants

Furthermore, advisers invariably counsel a conservative approach to investment, often telling schemes to confine their focus to the domestic market, thereby avoiding the currency risk, gearing and tax leakage associated with investing in international real estate.

For the full The Specialist report on property and infrastructure, go here to find the PDF.

Consultancy Aon Hewitt is no different in this respect, except that the firm is now asking schemes to consider a small satellite investment in vulture funds, so-called because they invest in distressed real estate assets.

Boosting returns

Vulture funds seek out investment opportunities with some degree of planning, development or leasing risk. 

Also known as value-added and opportunistic funds, such strategies are boosted by gearing of around 50 per cent and typically target annual returns in the mid-teens, says Nick Duff, a partner at Aon Hewitt.

“At the moment, we are looking at [these] funds,” he says. “There are some good managers out there who have a proven track record even during the downturn.”

Duff adds that he would rather invest in a well-developed property market with a vulture fund manager “who knows what he’s doing” than invest in an overseas market with a vulture fund manager whose track record he is unsure of.

Nevertheless, he says he would look at vulture funds outside the UK as well. 

Julian Lyne, head of global consultants and UK institutional at F&C Asset Management, says pension funds are adopting a barbell approach to property investment, whereby one end comprises long leases and ground rents and the other constitutes opportunistic real estate investments aimed at generating “double-digit absolute returns”. 

As investors have become more risk averse since the financial crisis, a change in appetite is starting to emerge.

It is not that investors are necessarily looking to take on more risk, but that they want a high return that is “underpinned by income for a relatively low risk”, according to Lyne.

“So either they invest in prime properties and get a lower return or else they take on some of this perceived risk and are rewarded by an income return,” he adds.

The consultants F&C has talked to are pointing to growing interest among larger pension schemes in an allocation to riskier opportunistic real estate funds.

But Lyne adds “it would be fair to say” that “perhaps” due to governance constraints, smaller pension schemes are showing little interest in opportunistic property investments. 

“It is a different sort of proposition than they’re used to,” he says. 

Not all institutional advisers are keen on vulture funds. 

Consultancy LCP, for instance, is put off by the gearing in these vehicles and deems the strategy unsuitable for both large and small pension schemes. 

The majority of the firm’s clients invest in property through UK-focused, core balanced funds which are usually ungeared and linked to a specialist property benchmark.

Portfolio diversification

Vulture funds tend to focus on capital return which is “less of a good natural diversification for pension schemes and a bit more of a return play,” says investment consultant Mat Thomas.

“We don’t see property as a suitable asset for targeting double-digit returns,” he adds.

For the full The Specialist report on property and infrastructure, go here to find the PDF.

Despite advocating an allocation to vulture funds, Aon Hewitt’s Duff says opportunistic funds, or funds of property funds, that invest in higher-risk real estate strategies are structured like private equity vehicles, in terms of being closed-ended and the type of fees charged.

“They are promising 15 per cent returns, which relies on gearing, but they charge a base fee plus performance fee above a hurdle rate, and investors face a huge illiquidity issue because the funds are closed-ended,” he says. 

“Do pension funds want and really expect that?”

Henry Smith is editor of MandateWire Analysis