Defined contribution pension funds that combine both private and listed real estate in their property investment allocations generate consistently superior returns compared with portfolios without a blended approach.
That is according to research sponsored by the European Public Real Estate Association (EPRA) and presented at its annual Insight event in Amsterdam on 14 January.
A UK pension fund portfolio that combines a 30 per cent international property shares allocation with non-listed funds delivered an annualised total return of 7.5 per cent a year, or 0.9 percentage point more than a portfolio with no real estate stocks, according to 15 years of performance data compiled by consultants Consilia Capital and The Townsend Group.
Alex Moss, Consilia Capital managing director, says: “No matter what period we looked at and irrespective of the property cycle, we found that an allocation to the listed sector enhanced the returns of the real estate portfolios of defined contribution pension funds. There is now a compelling body of research to show institutional investors that by sticking to the traditional non-listed strategy they are missing out on superior returns, as well as the benefits of liquidity and efficient pricing that come from integrating listed property companies into their real estate allocation.”
Nicholas Cooper, principal with The Townsend Group, says: “It is well understood that private real estate can be a beneficial component of a multi-asset portfolio, primarily due to the diversification that it provides. Real estate solutions within defined contribution schemes often require an enhanced level of liquidity. This study finds a blended portfolio, with a majority of direct real estate exposure through private real estate funds, can provide attractive risk-adjusted performance for investors. The diversification potential is also largely retained, especially when considering typical institutional allocations to the asset class.”
The study, which covers the period from June 1998 to June 2013, showed that a 70/30 blended portfolio generated a 13.6 per cent outperformance in returns compared with non-listed funds. For the decade to June 2013, a blended portfolio achieved a 38.7 per cent outperformance, while for a five-year period the difference was more than five-fold in favour, again, of the blended approach, the research revealed.
Fraser Hughes, research director at EPRA, says: “The results of the research are clearly in line with the findings of the Maastricht University report on global pension fund performance issued in 2012 – that investors who ignore the listed real estate market seriously risk underperforming those that embrace it. It only goes to bolster our opinion that listed real estate should form a material portion of all investors’ allocation to property.”
Consilia and Townsend tracked the performance of actual UK non-listed real estate funds and international property securities funds, while replicating a typical pension fund structure and its behaviour in rebalancing a portfolio quarterly and factoring in cash holdings.
The research quantified how integrating listed property into a DC pension fund’s real estate investments increases the portfolio’s volatility to 8.4 per cent, or two percentage points more than for a non-blended allocation. The superior returns, however, have a limited impact on the blended real estate portfolio’s Sharpe Ratio, which gauges the enhancement to returns from the additional risk.
The liquidity that stocks provide, lower transaction costs and the ease of diversification by property sector, region and globally are among the reasons that DC pension funds are warming to the listed real estate sector, according to a separate EPRA survey (Pension Fund Real Estate Investments) released in September and prepared by Consilia and Andrew Baum of Property Funds Research.
The UK’s National Employment Savings Trust indicated last year that it will earmark one-fifth of its total investment to Legal & General’s Hybrid Property Fund, which currently invests 30 per cent of its assets in a global real estate equity fund. NEST, which was established under reforms introducing automatic enrolment to the UK workplace DC pension schemes, indicates that its assets under management may rise to as much as GBP150bn by 2030.
Consilia’s Moss says: “NEST demonstrates how some DC pension funds are happy to proceed with a blended private and listed portfolio approach for their real estate investments because they recognise that the superior returns outweigh the incremental increase in volatility and reduced diversification benefits in their portfolio. We detect a growing momentum from DC funds that will follow suit.”