Investing in real – physical – assets is increasing in popularity as an investment strategy, finds Luisa Porritt
Record low interest rates have meant that over the past five years returns on developed market bonds have been poorer than expected. For the same reason, they are likely to remain a poor-performing asset class in the next five years.
‘Tangible’ or ‘real’ assets are proving an increasingly popular alternative, with asset managers reporting rising interest in the class among their pension fund clients.
David Adkins, chief investment officer at The Pensions Trust, says real assets give the best value in a low-return environment as, although they tend to be illiquid, investors benefit from the premium paid for locking up capital over a long period.
Olivier Lebleu, head of non-US distribution at Old Mutual Asset Management, adds that real assets are also attractive because their performance is often decorrelated from capital markets, and they can be an effective inflation hedge.
Tangible assets cover a broad spectrum of investments. They range from commercial and residential property, infrastructure and commodities, to shipping and forestry.
Before giving a manager an investment mandate, and to scrutinise performance, trustees must be aware of the different ways these sub-asset classes can behave.
Of all tangible assets, pension schemes invest most commonly in commercial property. Aberdeen Asset Management makes more than 4,000 introductions a year to the UK market, excluding off-market.
For office space, a quality asset is needed to reduce fluctuations in tenant demand, says Andy Allen, head of global property research and strategy at Aberdeen.
New buildings tend to be more efficient than restored ones, as they are higher and have smaller desks, so they can accommodate more people. They are also more energy efficient.
Part of the reason this asset class is popular is because it is easy to understand, since rent inflation is linked to a price index. Drawing on rental demand, commercial property is regarded as offering a dependable, long-term income stream.
Trustees should test managers on the quality of tenants, and request a breakdown of the sectors tenants operate in, says Alan Swallow, a senior pensions actuary at Cartwright Group.
They should also enquire about a lease’s structure: its length; how often it may be renewed; and whether rental increases are expected in line with inflation.
The income and capital volatility can be dramatic”
Several managers shun central London offices as they can be expensive and volatile investments. “They are a cyclical story – the income and capital volatility can be dramatic,” says Allen.
He prefers ‘second-tier’ property investments that offer value, yet still imply dependable income. This means a long lease with a perceived strong tenant, such as a university, government entity or supermarket.
Scott Jamieson, head of multi-asset at Kames Capital, also looks beyond central London, focusing on less fashionable areas where he believes a lack of new property construction and international demand will drive higher rents in the future.
In retail, changing consumption patterns driven by the growth of online shopping and lower consumer incomes makes this sub-sector difficult to gauge, says Allen.
Smaller schemes often seek exposure but do not invest directly”
Aberdeen, has, however identified opportunities in locations where people want to visit physical stores. The changing shape of retail is also having a positive impact on demand for industrial logistics buildings.
There are many different ways for schemes to access commercial property. Some large schemes invest directly, but they usually need to be £50m-£100m or above. Other means of investing include unlisted property funds, property shares, and listed real estate investment trusts.
Investing in funds allows schemes to diversify their geographical exposure, with managers today finding assets elsewhere in Europe, as well as in the US and Asia.
Smaller schemes often seek exposure but do not invest directly. They may instead gain this via diversified growth funds (DGFs), but must choose managers able to weather market volatility, says Cartwright Group’s Swallow.
For mature schemes, a DGF strategy that includes real assets is unlikely to be suitable, given the exposure to risk.
Student halls of residence are popular with large pension schemes. Although the private rented sector is yet to become an established market, it is developing fast, says Allen.
Residential property is a nascent asset class. Social housing debt involves lending money to housing associations that is secured against the homes they provide.
The advantage of this form of credit is it is highly rated, while investment horizons are long-dated, ranging from 20 to 40 years, says Jo Waldron, alternative credit client director for pension funds and insurance companies at M&G. But there is a lack of inflation-linked debt, as social housing debt is arranged at a fixed rate.
The Pensions Trust is not purposely avoiding residential investments, but reports these currently lack sufficient scale.
UK politicians would particularly like schemes to increase their allocation to infrastructure. But there are substantial hurdles, including a lack of assets relative to the c£2trn of pension fund assets that need investments, says Waldron.
Pension funds are happy to invest if there is an appropriate return”
Finding the right assets can be tricky. Pension funds are happy to invest if there is an appropriate return, but they will not be thrown into any deal, says Andrew Stephens, managing director of BlackRock’s institutional business. Investing in greenfield means taking on construction risk, whereas brownfield can be expensive without the returns expected on illiquid long-term investments, says Old Mutual’s Lebleu.
Interest in commodities has dwindled since prices began to fall across the sector last year. Schemes have had little appetite to invest in commodities for the past 18 months, reports Stephens.
Since commodities tend to be more correlated with the economic cycle than other real assets, the benefits of this asset class are less clear, says Lebleu.
An advantage, however, is that smaller schemes can access the asset class, via equities of companies operating in the sector: mining firms, for example.
Marine Capital, a specialist asset manager offering direct investments in ships on behalf of mainly pension fund clients, also operates as a financial manager. This means comparatively lower fees and greater transparency for the investor, while the manager can make better strategic investment decisions, says Gihan Ismail, a director at the firm.
Shipping is the world’s second largest mortgage market, valued at between $2trn-$3trn, but rarely makes up a significant part of a pension fund’s portfolio. Assets are usually accessed via shipping funds or private equity structures.
But schemes should be wary of this asset class’s sensitivity to the state of international trade, says Lebleu.
Larger schemes typically invest in timber and forestry assets, which can be accessed either via a third party fund manager or directly.
RBS’s pension scheme invests directly in timber, and this means performing their own due diligence and meeting with managers on a regular basis.
Capital expenditure is low and the asset has a natural growth rate based on sun and water. Lebleu adds that its cash-flow characteristics also make it suitable for maturing schemes.