Pension schemes can maintain and even enhance the important role real estate assets play in their portfolios by taking a global approach, according to new research from J.P. Morgan Asset Management.
The merits of pension funds investing in real estate are well known, with this asset class offering the potential to meet both income and return targets while offering diversification, which is especially valuable during the Covid-19 pandemic.
Over the past decade, real estate has become an established component of pension portfolios as investors have sought low volatility alternatives to fixed income. Allocations are typically biased to domestic markets and especially towards lower risk core assets, reflecting the qualities investors want from cashflow-matching assets.
Given that European core real estate has delivered decent returns over this period, pension schemes have had little incentive to move beyond domestic assets. This is compounded by the limited number of products offering diversification into global core real estate.
Expected returns for core real estate globally will still be attractive but may be lower compared to historical levels following the pandemic and associated interest rate cuts.
To meet these challenges, pension schemes are exploring new active management strategies or adding value-added and opportunistic real estate. The narrow dispersion of returns between top- and bottom-performing open-ended strategies suggests that performance from real estate is beta-driven, which makes identifying consistent alpha-generating managers difficult. Additionally, while adding non-core real estate assets may offset lower expected returns, it can increase the risk profile of a scheme's allocation.
While there is still a strong case for domestic core allocations, it can be maintained or even enhanced by going global. Returns for core real estate globally are expected to be lower in the coming years, but they remain attractive compared to expected returns from equities and fixed income.
Reallocating a portion of existing equity holdings to global real estate maintains or even modestly improves expected return while adding incremental cash income. The large and diverse core global real estate market can help pension schemes to create a solid portfolio foundation by allowing the potential to find opportunities outside domestic markets.
Economies around the world are exiting the pandemic at different speeds. By gaining exposure to a wider spread of geographies, pension funds can gain greater access to a range of real estate themes around the world.
For example, European real estate can offer defensive qualities while Chinese projects have relatively lower valuations and therefore greater growth potential, which may help build a diversified portfolio.
Looking further afield could open more opportunities for pension schemes in their real estate portfolios. This is the basis for new research from J.P. Morgan Asset Management, which shows schemes how they can maintain and potentially improve their domestic core real estate allocations.