Defined benefit schemes are increasingly investing in real assets, including property, infrastructure and forestry to use their inflation-linked characteristics to shore up portfolios against expected rate rises.
According to data from Financial Times service MandateWire, property was the clear favourite alternative asset over the past year, receiving more inflows than infrastructure, hedge funds and private equity (see graph).
There were 56 instances of inflows from the UK schemes interviewed by MandateWire in the year to March 2014, including awarded mandates and assets reweighted into property, amounting to nearly £4bn.
This was down from the previous year, which saw 59 instances, but up from the year of April 2009 to March 2010 which saw 35 awards.
According to the National Association of Pension Funds’ 2013 annual survey, more than a third of DB schemes had invested in commercial real estate, while a further 11 per cent had considered investing.
For the full The Specialist report on property and real assets, click here for the PDF.
The major themes in property investment in the past year are schemes upping their allocations and diversifying allocations to take advantage of opportunities, investment consultants say.
While ‘core’ commercial property has previously been the focus, many schemes are moving towards secondary property where better value can be found.
Ciaran Mulligan, global head of manager research at consultancy Buck Global Investment Advisors, says property aligns itself very well in a pension fund’s portfolio as it is a long-term asset, is tangible and has the income stream of bonds and the growth potential of equities.
“For most funds there is a case to be made for property,” he says. “[However] what those funds are investing in has changed over time.”
Nick Spencer, head of alternatives in the consultancy team at Russell Investments, says there has been an increased interest in property and real assets, in particular infrastructure.
“[Schemes] are thinking of broader ways they can add to the portfolio,” says Spencer. “We are in a situation where equities are around market highs... Rising rates will make fixed income returns rather muted.
“With that outlook, schemes are looking to diversify portfolios and that is where real assets are coming into their own.”
He adds that although UK schemes have been lagging their European counterparts it is expected that will follow with increased investments.
“People are interested in the different ways they can access real estate, the different purposes they can use it [for], and they are thinking both domestic and globally,” Spencer says.
Focus shift
Schemes have had a particular focus on core prime property which has performed well, but the spread in valuations between prime and secondary assets has seen a shift.
“At the moment we are seeing interest in moving to the slightly more secondary locations, outside that core prime. Now that the gap between the prime and secondary is so wide, there is a particular opportunity,” Spencer says.
The focus has been on properties in secondary locations around the country, however there is an opportunity for distressed buildings in prime locations.
“To move to slightly more value-added type strategies, where you look at secondary properties in prime locations – look to make them prime and get the uplift in both the investment and also the valuation premium in the market,” Spencer says.
Schemes are also diversifying into long-lease-type properties and there has also been an interest in debt strategies in the hope of larger, more stable cash flows.
For the full The Specialist report on property and real assets, click here for the PDF.
Buck’s Mulligan says that what schemes are accessing under the guise of property has changed.
“The funds we have pension [schemes] increase their allocation to have been the inflation-linked properties,” he says, which include long-lease property.
Schemes have also been looking at international, listed and residential property, Mulligan adds.
Schemes looking internationally are focusing on Asia, the US and distressed sellers in Europe.
“It has become a lot more varied in how pension funds are getting exposure to property,” he says. “Just because the accessibility into these sub-asset classes has increased.”
Real assets
MandateWire data show schemes were also diversifying into infrastructure. In the past year there were 33 awards, amounting to inflows of almost £1.5bn. This is up considerably from the previous year ending in March 2013, which had 24 awards, and from the year ending March 2019, which had just 13 awards.
There were also inflows of £25m in forestry.
The data indicate infrastructure could be a strong contender in 2014 with nine searches for the asset class recorded (see graph). This is compared with five searches for domestic property and one for forestry.
The NAPF survey backs this up, with almost a quarter (23 per cent) of DB schemes having made some investment in infrastructure, with a further 18 per cent of respondents considering investing.
Russell’s Spencer says schemes have been diversifying into real assets, with infrastructure remaining the most popular choice.
Buck’s Mulligan agrees. He says: “There have been flows into real assets due to the advantageous illiquidity premium.”
But Spencer says some are finding that actually executing the investments can be “challenging”.
Another concern is the limited opportunity set in the UK, although that may be evolving. Spencer says: “We are seeing the emergence of some global open-ended infrastructure funds, as well as selective close-ended funds.”
Some schemes are looking internationally as UK prices have been bolstered by strong demand, so some of the valuation opportunities can be better overseas.
There is also interest in farmland and timber as schemes look to diversify further. “The interest in farmland and timber have come from the larger funds that are looking to diversify and take advantage of the cash flows and long-term trends in those assets,” says Spencer.
However investing can also be a challenge for many investors, particularly with valuations looking high for timber and farmland, he adds.
“The way I think larger investors are addressing that is looking for very specific opportunities, where they can get the competitive edge,” Spencer says.
