The Parliamentary Contributory Pension Fund has simplified its property portfolio and invested proceeds in a European loans mandate, with a view to generating income.
While real estate has traditionally been popular for schemes looking for sustainable returns, asset classes such as secured loans can be attractive for funds seeking assets with contractual cash flows to help fulfil shorter-term obligations.
Senior loans have now become more mainstream, and for good reason
David Will, JLT Employee Benefits
The fund, which was set up for MPs, government ministers and other parliamentary office holders, notified members that it reviewed its property allocation at the end of the last financial year.
The review was conducted “with a view to increasing the fund’s allocation to income-generating funds and to simplify the structure of the property portfolio”, said the scheme.
Consequently, in March 2016, the scheme’s holding in the Morgan Stanley Global Real Estate Investment Trust was sold. Trustees are notifying members that this change was made because “the focus was to switch into assets that provide regular cash payments to meet the fund’s cash flow requirements”, said a House of Commons spokesperson.
The proceeds were invested in the M&G European Loans Fund and “the trustees continue to seek further opportunity to simplify the property portfolio”, according to the scheme.
‘Less risky than high-yield’
Senior secured loans, also known as senior loans, bank loans, or leveraged loans, are made to companies that are generally below investment grade. David Will, senior investment consultant at JLT Employee Benefits, said they have become “more mainstream, and for good reason”.
The loans are senior in the borrower’s capital structure and secured on the company’s assets. “They are, therefore, deemed to be less risky than some other asset classes, such as high-yield bonds,” Will explained.
“The variable nature of the interest payable means that senior loans have low duration and the price would not be expected to fall as a result of rising interest rates alone,” he added.
Will said senior loans can give some level of inflation protection, as historically, interest rates rose during periods of higher inflation.
“As senior loans are not typically found in traditional bond portfolios, they could provide valuable diversification benefits for a pension fund’s assets,” he noted.
He said property is still an attractive option for funds, but with some caveats.
“Generally, the London commercial rental market is a significant part of almost all property investment funds, and the threat of relocation from many prominent London businesses has reduced the perceived value of these investments,” he said.
David Curtis, head of institutional business UK and Ireland at Goldman Sachs Asset Management, said property has provided schemes with appropriate return and risk characteristics over the past few decades and “is a fairly significant asset class” for pension schemes.
Funding is one element when schemes are looking at how to invest in property, said Curtis. “But the other element is how strong their sponsor is.”
Useful for small schemes
There are many different ways of accessing property, from direct investments to indirect to REITs.
Which investments can cash flow negative schemes turn to?
Defined benefit pension funds will face significant pressures in 2017, including market uncertainty and potentially increased volatility. An additional issue many funds will have to grapple with is how to manage their investments as the scheme matures.
“It is very important to understand exactly what you want from your property allocation, and what role it will play in your scheme’s overall asset allocation before deciding on the best structure of your property portfolio,” said Keir Macdonald, analyst in consultancy Redington’s manager research team.
REITs can be a useful way to access property “for investors who are too small to build a meaningful, diversified direct property portfolio, which often requires a larger amount of capital to become sufficiently diversified”, he said.
However, they have a relatively high beta to equities, and as such an investor’s exposure to underlying properties is diluted. Macdonald said: “Some investors may even view REITs as an equity strategy with a tilt towards property.”
Simon Cohen, head of investment consultancy at Spence & Partners, agreed that “it is worth noting that investment in real estate investment trusts… is not quite investment in property, particularly in the short-term, as such investments are more like equity investments with equity-like volatility”.
