Using detailed data from IPD, this paper looks at the holdings and performance of 256 UK commercial real estate funds from 2002-2011. It concludes the more active funds, those further from benchmark holdings, outperform but are not accompanied by higher risk.
To access the paper click here
The $15 billion Australian super fund for hospitality workers, HOSTPLUS, has a 10 per cent allocation to infrastructure and is aggressively increasing its allocation to real assets. David Rowley spoke to chief investment officer, Sam Sicilia, about what the fund seeks from real assets.
A quarter of the $15 billion in assets held by the Australian defined contribution pension fund, HOSTPLUS, is held in unlisted property and unlisted infrastructure, and the fund is keeping a keen eye out for more.
While other funds might hold back on the temptation to buy a share in an airport or an office block, due to cash-flow fears, there is less restraint for HOSTPLUS, where the majority of members are between 20 and 40 years from retirement.
Including private equity, the fund currently has about 40 per cent in illiquid assets; but with its demographics, it could, in theory, raise that figure to more than 70 per cent, according to chief investment officer Sam Sicilia.
“When an airport is available for sale, that is the only time you can buy it,” he says. “You do not get a second bite. Even if you have reached your hypothetical limit to airports in allocation terms, it is OK to go over that limit to secure that asset, because it is unlikely to be there if ever you are underweight.”
To stay alert to opportunities, the fund has employed in-house experts during the past 18 months, including Jordan Kraiten as head of infrastructure and Spiros Deftereos as head of property.
A milestone in the fund’s step to build up its allocation to real assets was its decision in July/August 2010 to divest itself of sovereign bonds.
This was in part due to concerns about the health of these assets; but it was also due to the realisation that infrastructure and property produced the sort of returns you would expect from government bonds.
While switching out of bonds hurt in 2011, because the unexpected fall in interest rates from around 2 to 1 per cent pushed bond returns through the roof, it has paid off handsomely ever since, Sicilia says.
“There will probably never be a large allocation to sovereign bonds in this fund again because of our member demographics,” he says.
Prior to the global financial crisis, sovereign bonds largely abided by the laws of economics but from 2008 onwards they were behaving erratically.
“It was much riskier to be in the bond space, when the world departed from fundamentals, than being in equity markets – that is not what we learnt in finance school,” he says.
Of HOSTPLUS’ 15 per cent allocation to property, 9 per cent is defensive and acts in a way most investors would hope a sovereign bond would act.
Casselden Place, a prime piece of office space in the centre of Melbourne, Australia is typical of this approach. This property has space let to large corporates or government departments on 10-year leases and these have strong credit qualities.
“The rent they pay is like the coupons of a bond and the risk you are taking is essentially sovereign risk,” Sicilia says. “That is not a growth asset; rather it is predominantly a defensive asset that behaves like a bond.”
Process
The confidence HOSTPLUS displays regarding real assets comes from experience in property and infrastructure – the latter of which it first started investing in, in the early 2000s.
Once upon a time the fund invested through managers – “you would give a cheque to a fund manager and say, ‘the best of luck’” – but now it invests only in unlisted property and unlisted infrastructure, rather than listed forms of these asset classes; and along its path to sophistication it has worked out the defensive and growth parts of its property and infrastructure portfolios.
It has also become clear about the return profiles, the yield and the liquidity of each – so much so that the fund can move quickly when it sees something it likes. Sicilia says it is a three-part process.
“When the next asset in infrastructure or property appears before us, we can make a very quick determination as to whether it is appealing and worth some initial due diligence to take it to the board to see whether it is appealing to the board,” he says. “Only then we will do full diligence, which is quite expensive.”
This confidence around purchasing also extends to the growing expertise of IFM (the manager it has a share in), the fund’s consultant JANA Investment Advisers and its internal investment team.
Government deals
For the future, Sicilia foresees a time when funds like HOSTPLUS will broker infrastructure deals directly with government and believes it is inevitable governments will tap such funds for risk-free funding of greenfield sites – an idea that has so far faced opposition from the Australian Treasury.
Otherwise, he says superannuation funds are unlikely to invest in projects such as toll roads or bridges where there is risk of future revenue disappointing or construction risk.
“Why would we invest in that, when it is safer to invest in an operating infrastructure asset or the building down the road,” he says.
He describes such an arrangement with the government as “underwriting sub-optimal investment opportunities”. In this model, a 10-year government bond would be raised for a specific project, the return would be underwritten by the government bond rate and would be guaranteed for the term of the investment. Previously, the response from Treasury to the proposal was that it was not their role to underwrite a rate of return for infrastructure investors, though the noises the current government are making hint at change.
Sicilia believes time is on his side.
“The parcel of money in superannuation is growing and creating such a big opportunity set to deploy it for the benefit of the country, across the whole economy, that these ideas will ultimately see the light of day,” he says.
The giant Dutch pension fund, ABP with €300 billion ($456 billion) in assets, is considering using smart beta benchmarks. While APG, which manages ABP’s assets has been using smart beta strategies for implementation for three years, the fund is taking it a step further and is now considering tilted benchmarks. Amanda White speaks to head of investments of the executive office at ABP, Jeroen Schreur.
The general pension fund for Dutch employees, ABP, is in good shape. It now has a funding ratio of 105.9 per cent and it can remove last year’s pension reduction (of 0.5 per cent).
With a long-term strategic asset allocation split broadly 60:40 the board, and executive committee, concentrates on diversifying that broad asset mix, reducing investment costs and finding better ways of implementing its policy.
For the past 10 years the long-term investment policy hasn’t changed much, with the asset allocation done within a risk framework based on the asset-liability study. (see asset allocation below).
Head of investments of the executive office at ABP, Jeroen Schreur, says there has been a slight shift in the asset allocation, and for the three-year period from 2013-2015 the fund has increased its strategic allocation to global equities and emerging markets by a collective 4 per cent; this offset by a collective 4 per cent lower allocation to real estate, GTAA and infrastructure.
“This change has partly to do with our size,” Schreur says. “From 2010-2012 our weight of equities has grown. In order for us not to sell – we’d be forced to sell to rebalance – we have made some smaller changes to asset allocation to bring in line the portfolio.
“The actual portfolio looks a bit different to the strategic asset allocation and we try to not be mechanical about rebalancing but look at the best way to rebalance, sometimes being forced to sell equities is not the best thing and it’s better to be overweight, versus the norm, for a little while.”
The investment executive office within ABP, which only has four employees, advises the board on policy, and works with and monitors APG on the investment implementation of the investment policy.
Schreur says that his office is always working on the details of the investment plan. In addition to the strategic investment plan every three years, a new plan is drafted every year looking at economic scenarios, contingency scenarios, constraints, bechmarks, hedging policies, ALM statistics ant implementation.
This annual review takes on different topics, including this year a discussion about the new regulatory framework within The Netherlands and the potential impact on discounting liabilities and inflation aspects of the contract.
Another topic under investigation this year is the idea of smart beta benchmarks.
ABP, via APG has been implementing the strategies that broadly fit under the smart beta umbrella for about three years.
In an interview in April last year, Ronald Wuijster chief client officer at APG Asset Management explained to conexust1f.flywheelstaging.com the practice started in commodities, where it excluded some of the commodity classes, such as natural gas, that have certain behaviours, in a bid to have a more optimal beta exposure.
And in its equities exposure, the fund has more than 50 tilts along the “quant spectrum”.
Between 50 and 60 per cent of the developed markets equities exposure is managed using quant strategies and APG has tilted for value, momentum, quality, fundamental indexing, and risk.
“We created a separate asset class for minimum volatility, and we are now researching to allocate to credit and emerging market equities in that. Clients can allocate to that building block,” he says.
APG also applies smart beta to real estate and in particular looks at the environmental spectrum in direct property, overweighting to environmentally friendly buildings.
Similarly, in the fund’s credit analysis, it will look at minimum volatility and quality strategies, and is increasing the focus on quality companies.
“Valuation is relatively basic but the majority of investors don’t pay attention to it; they favour glamorous stocks and that’s accepted because of the short-term pressures,” he says. “Many investors are talking about smart beta, but there are not many doing it. The ideas are less than half the exercise; it is hard to execute and implement. We are well advanced but we could also do more; we are still trying to think of new ways.”
Now ABP, headed by Schreur in close consultation with APG, is undertaking a project about the appropriateness of using smart beta benchmarks.
“We are investigating it as part of the investment plan for next year,” Schreur says. “We are working with APG, providing more analysis and facilitating debate with the investment committee.”
The work is beginning with developed market equities, and examining the appropriateness for each asset class.
“For some asset classes, it may not add value or there are a number of definitions of smart beta benchmarks.”
ABP is also working closely with APG to monitor the costs of asset management.
“There is a trade-off between return, risk and cost and we are looking at cost-effective implementation of our investment policy.”
For example APG is currently looking at building its own private equity team, in a bid to reduce costs and move away from a fund-of-funds structure.
APG has managed ABP’s assets since it was created in 2008 when the board of trustees and management company split.
The investment part of the ABP executive office has four staff including Schreur and has specialist functions including risk management, policy development, and legal aspects to assist the board of trustees.
“We have a very long term relationship and contract with APG and we are not looking to change that. We do work with them intensely when they want to make important changes. For example at the moment private equity is managed externally and we are monitoring how closely APG is building expertise inhouse,” he says.
The ABP strategic asset allocation is:
Developed market equities 23%
Emerging market equities 8%
Real estate 9%
Infrastructure 3%
Private equity 5%
Hedge funds 5%
GTAA 1%
Commodities 4%
Opportunities 2%
Government bonds 14%
Index-linked bonds 7%
Corporate bonds 16%
Alternative inflation 3%
This paper by the Federal Reserve Bank of New York looks at the equity risk premium information from 20 models and estimates the ERP for various time periods. Extraordinarily it finds that the (preferred) estimator places the one-year equity premium in July 2013 at 14.5 percent, the highest level in 50 years and well above the 10.5 percent that was reached
during the financial crisis in 2009.
The models also show broad agreement that the term structure of equity risk premia is high and flat: expected excess returns at all foreseeable horizons are just as high as at the one-year horizon. A high equity premium that is not expected to mean-revert in the near future is an unprecedented phenomenon. Because expected dividend growth has not been above average in 2013, the paper concludes the high equity premium is mostly due to unusually low discount rates at all horizons.
To access the article, The Equity Risk Premium: A Consensus of Models, click here
As part of the broader trend to become professional organisations, pension funds and soverieng wealth funds are expanding geographically with the establishment of satellite offices. This expansion raises concerns of governance, culture, politics and talent.
This paper looks at the case studies from 12 funds that have launched or considering launching satellite offices and offers a set of principles that could guide investors on this path.
To access the paper click below
Getting closer to the action -why pension and sovereign funds are expanding geographically
This year the $12 billion Ohio School Employees Retirement System is prioritising projects that fulfil the board’s desire to find income from alternative sources and manage risk, including allocating more to real assets, and initiating an RFP on a risk management system. Farouki Majeed speaks to Amanda White about the fund’s investment program.
With a fund the size of Ohio School Employees Retirement System (SERS), director of investments Farouki Majeed is enjoying the ability to be more nimble and opportunistic in the investment approach.
Previous to this role he spent five years at CalPERS as senior investment officer of asset allocation and risk management. While clearly there are many benefits to working at a fund like CalPERS, at 20 times the portfolio size of Ohio SERS it also has limitations. A $12 billion portfolio, fully outsourced, is a different beast to tame.
Ohio SERS completed its asset liability study last year, and this year will implement the minor tweaks to the strategic asset allocation, which include reducing the hedge fund allocation from 15 to 10 per cent, and increasing real assets from 10 to 15 per cent.
“We have had a shift to tangible/income related returns because of low interest rates and our need to look for income from other sources,” Majeed says. “We are looking at not just total returns but from income and growth and other sources.”
The real assets bucket, which was previously only a real estate portfolio, also includes infrastructure and REITs, with the fund also considering timber investments.
While the hedge fund program has been reduced, the fund is still committed to using hedge funds, and sees the recent move as more of management of the program, which has grown quickly since its introduction in 2009.
Majeed says the hedge fund portfolio, which is all direct, is also morphing from a 50:50 equities and fixed income substitute, to a more diversified exposure.
“We are making it more diversified across hedge fund exposures and reducing our equity beta. This means we are looking at event driven, relative value, and global macro strategies.”
In addition to the strategic asset allocation review every three years, in the past year the fund introduced an annual review of investments and capital market expectations so it can make tweaks to exposures along the way.
“This is a new thing to be more dynamic, but it doesn’t mean it will always result in change,” Majeed says.
For example allocating to inflation-sensitive assets has been a consideration for the fund, and at the annual investment review last week, it was decided an allocation shoud remain on watch.
“We have been questionoing the role in our asset allocation of the exposure to inflation-sensitive assets. Last year we said it was not the time to allocate, because of outlook for inflation and disinflationary trends. Last week we reviewed that again and decided we would not allocation to inflation-sensitive assets,” he says. “These are the types of things we look at it in an annual review.”
The fund is also looking at the feasibility of allocating up to 5 per cent on opportunistic investments.
“We already have about a 1.5 per cent allocation to a variety of opportunistic investments, which are organised with a special purpose to take advantage of certain anomalies, such as the concept of bank deleveraging in Europe.”
Ohio SERS already has two different funds targeting European banking debt, and Majeed says the 700-odd US banks on the FIDC’s official list of problem banks are also a target.
“They are under capitalised and had to write off assets, this is an opportunity for us to act as a capital provider,” he says.
With a strategic allocation to fixed income of 19 per cent, and an actual allocation closer to 15 per cent, Ohio SERS has a lower than average allocation to the fixed income.
While opportunistic allocations and hedge funds are a fill in for fixed income, the allocation is still underweight, and overweight equities.
Within the equities allocation, US and European equities are overweight and there is a slight underweighting to emerging markets. The overall allocation to equities is 45 per cent, with a further 10 per cent in private equity, and is split roughly 50:50 US and non US.
While the overweight position in equities is quite deliberate, Majeed says it is only a single grade, and the fund is discussing with the strategy team the option of a tactical asset allocation overlay.
“Underweight fixed income and overweight equities is a single trade, when it goes wrong it can go badly, so we need more breadth with our tactical positioning. We are looking to possibly partner on an overlay, purely derivatives and based on valuation, we are interested in style premia as well.”
Ohio SERS is looking at more optimal ways to manage its allocations, and understanding its exposures in risk terms, and is in “RFP mode” for a risk platform.
“We want to more optimally manage allocations. An internal risk system gives you some additional insights and metrics into positions, understanding exposures in risk terms and allocating accordingly.”
The board, which had an offsite last week, is also finalising its investment beliefs. While the fund has not yet adopted those yet, Majeed says beliefs around active management, risk premia, long-term holdings, and sustainability are being considered.