UK pension schemes have invested heavily in their local market but Helen Morrissey asks if they can benefit from looking further afield
- UK schemes retain a strong home bias in their property exposure
- Many have been reticent to return to other markets such as the Continent after experiencing losses during the financial crisis
- Local knowledge of a real estate market is important
UK pension schemes have historically held a strong home bias when it comes to their real estate allocation. Such a stance makes sense given that it is always easier to invest in what you know and the UK market is also highly transparent. Indeed the Jones Lang LaSalle Global Transparency Index 2014 ranked the UK as the most transparent real estate market out of the 102 markets studied.
While such an approach has served schemes well there are now signs that UK pension funds are starting to look further afield for their real estate exposure.
"There is an element of home bias but you can understand this given managers have more knowledge of their local market – it is harder to achieve this level of knowledge on a global scale," says MSCI's vice president – client coverage, Douglas Rowlands. "However, after the global financial crisis it was seen that investing on a more global scale could bring you more diversification and less risk for your portfolio."
Lucy Williams, M&G Real Estate's director of institutional business in UK & Europe, agrees that schemes are widening their outlook when it comes to real estate and are tentatively exploring other geographical locations.
"UK defined benefit schemes have invested in core plus UK balanced funds for the past five years and have seen great returns," she says. "More recently we have seen them looking further afield – maybe looking to invest in the regions or looking at more alternative areas such as student accommodation or the private rental sector. Now we are seeing them looking tentatively at European property markets."
Global financial crisis
While overseas markets, such as those in Continental Europe can offer real benefits to a scheme portfolio memories of the global financial crisis mean many have been hesitant. However, Williams believes now is a good time in the cycle to get involved.
"In the past, pension funds would do this through fund of fund structures investing in highly leveraged funds with complex loan structures around the investments," she says. "Investors lost money on such vehicles during the global financial crisis and so there has been some reticence about re-entering this market. However, we believe that now is a good time to get back into European markets as they tend to follow the UK, which has seen yield compression followed by rental growth."
However, she adds: "You do still need to be careful where you invest in Europe."
M&G Investments recently launched the first institutional fund to invest in Continental European long lease property. Its first investments, totaling €100m (£78m), are in the leisure and retail sectors in Belgium and Portugal. Exchange on two further deals in Germany and Ireland is expected shortly and further opportunities are under review.
Schroder Real Estate’s head of indirect investment and research Neil Turner agrees that times are changing and that schemes are now able to access appropriate vehicles to help them invest overseas: “I think things have been changing for quite some time,” he says. “If you look at scheme portfolios their equity portfolios went global some time ago. I think what has held real estate back is that there weren’t the vehicles available to schemes to help them do this and so 10-15 years ago schemes had to go direct which brought significant hurdles. In recent years we’ve seen the necessary vehicles developed to facilitate investment in overseas real estate.”
However, care needs to be taken as one market can differ markedly from another in terms of the data available, and strong research capabilities are needed to gain a good level of understanding of how a market works.
However, Schroders' Turner believes schemes should not be put off by this: "The UK real estate market is large and transparent and has had a good run in recent years," he says. "However, it accounts for less than 10% of the global real estate market so looking overseas makes sense for diversification purposes."
Understanding the markets you hope to invest in is vital according to MSCI's Rowlands. "There is more information out there now and that does help people but it can be difficult," he says. "Local knowledge is very important and that is why we have seen an increase in joint venture style investing whereby funds will go into partnership with local investors and we are seeing smaller investors going through multi manager funds for instance. There are many different routes into the market, most of which are appropriate, but all of which require careful oversight and risk management."
M&G's Williams agrees that good research capabilities are vital. "We have a strong research team able to target the right assets in the right location," she says. "You have to be quite selective about where you target and a strong research capability combined with on the ground resource is very important. Different markets can act in a very different way to the UK and if you choose well then looking at other markets can prove to be a great diversifier for your portfolio."
So while schemes maintain a home bias in their property allocations, there are signs that some are looking to expand their horizons to diversify their portfolios and safeguard the long term inflation linked income streams that are so important. However, it is fair to say not all markets operate like that in the UK and thorough research must be undertaken to ensure you choose the markets that will deliver the diversification and returns needed.
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