The 800-pound gorilla of the real estate market, sovereign wealth funds, is increasingly exercising its muscle by investing directly in property as a way of cutting fees and potentially achieving better returns, new research finds.

The latest snapshot of sovereign wealth funds’ interest in property by alternative-asset researcher Preqin shows that 85 per cent of sovereign wealth funds now invest directly in real estate.

Sarah Unsworth, a Preqin analyst, finds the highest number of direct-real-estate investors are also the biggest sovereign wealth funds, with more than $250 billion in assets.

 

High rollers from the East

Funds from emerging market economies in the Middle East and Asia dominate the list of sovereign wealth funds that are the biggest investors in real estate (see table).

Unsworth’s research shows that the total combined assets of such funds now stands at more than $44.62 trillion and increased by nearly 15 per cent since 2011.

Alex Jones, a Preqin senior analyst, says that the push for direct investment in recent years comes amid a backdrop of increased allocations to alternatives by sovereign wealth funds.

Average target allocations to property were 7.8 per cent in 2011, down from 8.4 per cent in 2010, while average actual allocations were 7.5 per cent in 2011, up from 7 per cent in 2010.

Average target allocations have come back slightly as older institutions accomplished the push to expand alternatives allocations, as newer sovereign wealth funds have just begun to expand alternatives programs.

“While every institution is different, the trend is typically that sovereign wealth funds will tentatively explore alternatives and ramp up their allocations over a period of years,” Jones says.

“As a result, we’ve seen an overall trend of increasing numbers of sovereign wealth funds getting involved in private equity, real estate, infrastructure and hedge funds over the past years.”

Middle Eastern funds dominate the list of the sovereign wealth funds that are the biggest investors in property. According to Preqin, the Abu Dhabi Investment Authority invests more than $47 billion (see below).

 

Top five sovereign wealth funds by allocation to real estate

rank

sovereign wealth fund

country

allocation (millions)

1

Abu Dhabi Investment Authority

United Arab Emirates

$47,025

2

Qatar Investment Authority

Qatar

$25,651

3

Government of Singapore Investment Corporation (GIC)

Singapore

$24,750

4

China Investment Corporation

China

$20,479

5

Kuwait Investment Authority

Kuwait

$9,768

*Source: Preqin

 

Direct or indirect?

Jones says that sovereign wealth funds are typically large, sophisticated and experienced investors in property and are, therefore, ideally suited to direct investment.

Some sovereign wealth funds, such as Qatar Investment Agency, even have their own subsidiaries set up purely to invest in real estate,” he says.

“The big draw of funds is the skill and talent of the fund managers. However, if you have the requisite in-house talent and resources, it makes sense for them to avoid the fees associated with fund structures and tap into the potential for higher returns by sourcing investments directly.”

When funds do choose property funds, 59 per cent invest in private funds while 35 per cent choose listed-property funds.

Preqin finds that US real estate is proving popular, with 79 per cent of sovereign wealth funds investing in US property market-focused funds.

This is followed by 57 per cent of sovereign wealth funds investing in Asia-focused funds, 54 per cent in Europe and 32 per cent in the Middle East and North Africa.

Sovereign wealth funds have also been prepared to invest in higher risk property strategies.

Opportunistic and value-added funds were the most popular strategies, favoured by 75 per cent and 65 per cent of sovereign wealth funds, respectively.

Funds have also looked to manage the overall risk of their portfolios in uncertain market conditions, with 55 per cent investing in less risky core-property funds.

Debt and distressed-real-estate funds have also proved popular with sovereign wealth funds in the current market conditions, attracting 55 per cent and 45 per cent of institutions.

The least popular strategies were fund of funds and secondaries funds.

 

Managing surplus risk enables pension plans and endowments to align their asset allocations with their future obligations.

Market Insight:Analyzing Hedges for Liability-Driven Investors seeks to better understand the drivers of surplus risk and to analyse the potentially subtle impact of specific hedges.

In Goldberg and Kim’s case study, a term-structure hedge using an interest-rate swap substantially lowers surplus risk as expected. However, a credit hedge using a default swap elevates surplus risk.

To read more click here

 

 

The Global Real Estate Sustainability Benchmark (GRESB), which will launch its third annual sustainability survey today, has announced a partnership with the Global Reporting Initiative to enhance sustainability reporting.

The survey allows participating fund managers to benchmark their portfolio on environmental and social performance against their peers.

The GRESB Foundation is backed by 30 institutional investors with more than $1.7 trillion in combined capital and the survey acts as a tool for those investors to start a dialogue on social and environmental issues with their real estate managers.

Combined, they have an average stake of more than 4 per cent in each of the listed property companies that responded to the survey last year.

In 2011 the survey covered 340 real estate managers, 21,000 properties with a total value of $928 billion.

These properties emit about 34 million tonnes of carbon dioxide, demonstrating that institutional engagement with the property sector can have a substantial impact on the environment, according to the 2011 report.

Evidence of such an impact is that the 2011 combined emissions represent a 1.8-per-cent reduction from the previous year.

The survey, which was designed in 2009, captures more than 50 data points of environmental and social performance integrated into the business practices of each real-estate company or fund.

Last year listed-property funds’ average score was 41 out of 100.

Colonial First State Global Asset Management was the highest ranking manager.

 

To participate in the survey click here

Thank you to all our readers who responded to the Top1000funds.com Audience Behaviour Survey.

The survey’s overall aim was to allow us to better tailor our portfolio of products and events to you our readers.

Some of the interesting findings included that our typical reader is aged between 41 and 50 and earns between $96,000 and $150,000 a year.

They are fans of apple products, with almost half owning an iPhone, closely followed by Blackberry users, and 37.3 per cent own an iPad.

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The winner was a portfolio manager at a Dutch fund who wished to remain anonymous.

Property investors should look beyond the current languid growth in developed market economies and position their portfolios for a recovery in the world economy in 2013 and 2014, Mark Roberts the global head of RREEF Real Estate says.

Roberts, who also chairs the National Council of Real Estate Investment Fiduciaries (NCREIF), points to initial yield spreads for property, that are wide compared to bonds and real-estate capital values that remain well below peak levels, as indicators of the growing attractiveness of the asset class.

Along with potentially attractive valuations and solid income growth, Roberts says that the lack of new construction in developed markets in the US and Europe also adds to the case for investing in property.

“If you go back in time and buy when there is limited new construction, you stand a good chance of producing good relative performance. So it is the initial yield spreads, it is having values that are below replacement cost and it is also a limited amount of new development,” Roberts says.

“Now, is it like that everywhere? The answer is no. Globally what you have to look for is what are the cities that have exposure to the type of competitive advantages or industry concentrations that are going to benefit from any recovery.”

In its latest global market outlook, RREEF recommends being overweight the US and Asia Pacific region, while underweight Europe.

A typical global portfolio would be split 34 per cent between the US and Asia Pacific, with Europe making up the remaining 32 per cent.

Roberts argues that last year saw an inflection in the US property market, with vacancy rates falling as unemployment fell.

Typically, a 1 per cent fall in the rate of employment leads to a 1 to 1.5 per cent drop in commercial vacancy rates nationally, he says.

Roberts points to the initial yield spreads for property relative to bonds that have reached historic levels and stand in excess of 400 basis points, compared to a longer term average of 100 to 300 basis points as an indication of the attractive value of property.

In markets like the US and the UK, property prices are still at least 10 to 15 per cent off their peak levels, he says, with little new construction adding to limited supply of core, high quality properties.

RREEF predicts that total returns in a majority of markets and sectors globally will range between 6.5 and 11 per cent, providing similar returns to equity with less volatility.

Roberts expects these fundamentals to result in increased capital flows into property in 2012.

“Property has always been the smallest midget at the circus, so to speak,” he says.

“Property has come of age as an asset class and there is a lot more transparency in terms of the securities, debt and listed markets. People are able to price risk better and there is growing transparency globally.”

Allocations to property by large institutional investors are holding steady at between 8 and 12 per cent, according to Roberts.

 

Asian allocation to real estate rises

However, RREEF is seeing growing interest from Asia.

Niel Thassim, RREEF’s head of the Asia Pacific region, says that the manager has raised more than $2 billion from Asian investors in the past two years to invest in core properties in what he describes as gateway cities in developed markets.

RREEF expects growing capital flows into property from large pension funds in Japan, South Korea and China, which Thassim says have traditionally low levels of allocation to real estate of less than 1 per cent of portfolios.

“We are seeing a lot more exposure in Japan, Korea and China to real estate from the pension fund side,” he says.

While funds have typically been interested in the equity side of property, Thassim says there is also growing interest in debt opportunities in developed markets.

In the Asia Pacific region RREEF recommends targeting the retail and logistics sectors more broadly and the office sector selectively, particularly in Australia and Japan.

Retail and logistics-focused commercial space is aimed at tapping into the growing middle class in the region, with the need to upgrade obsolete properties to cater for growing demand.

These sectors are predicted to have stronger income growth than office and residential sectors.

In the US Roberts says that the modest pro-cyclical approach that focuses on the industrial and office sectors.

While apartments have performed strongly, Roberts argues that investors are “waking up to the industrial market” after seeing 125 million square feet of warehouse space absorbed nationally, which is a return to historical averages.

“The initial yields and the cap rates are 200 or 250 basis points higher than the apartment sector, so it has a higher income yield, and on the growth side, when you look at apartments you are only going to get growth through increases in rents for a couple of years,” he says.

“But when you look at the commercial sector, you get the benefits of declining vacancy, rent growth and rents growing up to market when you start looking out to 2013 and 2014.”

Roberts recommends investors look to cities and regions that will benefit from a recovery in global trade and/or have resilient competitive industries.

These include cities like Hong Kong and Singapore in Asia and in Europe trade centres such as the German city of Hamburg. In the US Roberts points to cities such as Boston and the San Francisco Bay area as examples of cities with industries that are resilient to economic downturns.

 

The recent rally on global markets does not mean that the risk environment has abated Towers Watson’s global head of investment Carl Hess has warned.

Speaking from New York prior to the launch of the consultant’s report Global Investment Matters, Hess says that while the risk of the imminent collapse of financial markets has lessened, the world economy still faces a tough road to recovery.

“Where we have just been is the crescendo of the great debt cycle and we have kind of unwound a small amount of it but we have an awful lot to go,” Hess says.

In its annual snapshot of the world economy and predominant investment themes, Towers Watson names its 15 top risks. According to Hess, the high debt, grinding austerity and slow growth facing developed countries is reflected in the top five risks because the world economy is fragile and has little room to absorb unexpected shocks.

 

Towers Watson top 15 risks:

Rank

Risk Description

1

 Depression Debt-deflation trap; falling growth and incomes

2

 Sovereign default Default by a major developed country on its debt

3

 Hyperinflation Extremely high inflation

4

 Banking crisis Balance sheets cannot absorb another shock

5

 Currency crisis Extreme movement between floating rates

6

 Climate change Diversion of capital to mitigation uses

7

 Political crisis Rise in power of extremist groups

8

 Insurance crisis Insolvency within insurance sector

9

 Protectionism Reversal of movement towards free trade

10

 Euro break-up At least one member leaves the euro

11

 Resource scarcity Peak ‘stuff’ (such as energy, metals, food, water)

12

 Major war A major global conflict

13

 End of fiat money Return to a gold standard

14

 Infrastructure failure (Temporary) interruption of grid/networks

15

 Killer pandemic Contagious disease with very high mortality

 

The last time the global investment consultant conducted such a risk analysis was in 2009.

Since then it has dropped its more dire risks of an end to capitalism and excessive leverage, causing a collapse of the financial system.

While it has eliminated excessive leverage as a stand-alone risk, Towers Watson has detailed a number of less extreme financial-system risks that are caused by too much debt.

A number of new entrants made the new list including resource scarcity and infrastructure failure.

The risks identified focus on a 10-year window, with much of the more dire consequences associated with resource scarcity falling beyond this period.

However, Towers Watson points to the potential for price spikes in major economic outputs and increased price volatility of basic commodities as potential risks to global economic growth in the next decade.

The increased interconnectedness of societies and their dependence on modern technology has meant that the failure of key infrastructure such as an electricity grid or a computer network is also a new risk.

Towers Watson points to the likely social unrest and disruption to economies that could eventuate from such an event. The consultant says that the recent hacking of Sony Playstation customer accounts is an example of where cyber-attacks could lead to economic losses for a company and its investors.

In its assessment of what it is seeing from investors, the report notes an increased focus on asset allocation and portfolio construction, particularly under-delegation in decision-making around them.

The consultant says that funds typically are leaving the decision to their board and/or investment committee who act on advice from a consultant.

“This approach can limit access to the skills required for portfolio construction or slow the pace its skills can be applied,” the report states.

It points out a growing recognition among investors that greater resources need to be committed to portfolio construction, which is driving the growth of internal teams.

For smaller funds this could involve hiring a team via the appointment of a fiduciary manager.

“We expect funds to spend more in the future on recruiting portfolio-construction skills and less on active management,” the report forecasts

 

Delegation and all-weather insurance

In its discussion of delegation in Global Investment Matters, Towers Watson says that funds have delegated too much authority to asset managers to construct mandates.

The report goes on to say that funds can recoup much of the cost of a fiduciary manager and/or building an internal team focused on portfolio construction through achieving a more thorough approach to structuring mandates in various asset classes.

“Our experience to date has been that once a fund has recruited these resources, whether they be an internal team or a fiduciary manager, their ability to restructure some of the mandates in the alternative asset class alone can more than offset the costs of these resources,” the report states.

While investors can sleep slightly easier now that the systematic failure of financial markets is no longer the overriding concern it was last year, Hess warns that investors must think broadly about the risks still out there.

“What may have gone away is the imminent collapse of the financial system but it has been replaced by the slow rot,” Hess says.

The list of extreme risks is a way for investors to focus on what risks they see as most likely and position their portfolios accordingly.

Diversification and hedging are two predominant themes that Towers Watson has been pointing out to its clients.

Hess says that investors should be thinking about ensuring their portfolios have an all-weather effect that can deal with unexpected events.

“Really think about hedges, we are not talking about taking the whole portfolio and putting it under the mattress, but thinking about some 5, 10, 15 per cent of the portfolio might be devoted to some asset classes or themes which might flourish in these environments.”

Depending on the risk profile of the investor and the risks an investor deems most likely, this could involve a strategic allocation to cash or investing in hard assets such as gold.

“For risk that involves the breakdown of monetary systems, you will want to think about a hard asset like gold and going back to this original storehouse of value,” Hess says.

He warns against investors being overweight risk assets, saying that despite equities being attractively valued relative to bonds, the recent rally should give them pause for thought.

“Equities are not particularly cheap and they are not particularly expensive, we thought they were attractive at the beginning of the run and now they are just all right. Now is the time to think about what else can you do,” Hess says.

“There is just not necessarily all that much that looks like stark good value at the moment.”

The report recommends investors do not increase the aggregate risk level of their portfolios and instead take a neutral stance while looking for attractive relative valuations.

Investors who chose to look for opportunities in the short term through dynamic asset allocation should focus on assets with ‘high yields, good balance sheets and little exposure to European event risk’.

In dealing with fixed income and sovereign risk, Hess says the consultant has been working with asset managers to construct fixed-income indices that are do not focus on the biggest issuers of debt but rather on a debtor’s ability to repay.

“The notion of the risk-free rate seems to be dying a pretty quick death, so what we have been suggesting is within the bond portfolio do look for diversification of issuer, of currency and diversification of credits,” he says.