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Property proves its long term valueFebruary 26 2004
Property has been one of the best performing assets classes over the last 20 years. Despite this consistently robust level of performance, property remains the poor relation among pension fund investment portfolios with typical weightings averaging between 5 to 7 per cent. Equities has been the preferred asset class with weightings of around 70 per cent of pension funds with the balance in bonds, cash and other derivatives.
Over time IPFPUT - specialising purely in property markets - has been achieving consistently strong returns over 10 years of 18.7 per cent and 12.8 per cent pa annualised over 20 years. Given the size of our property portfolio, valued at approximately € 600 million, we have become an effective proxy for the Irish market.
And we have been trying to encourage long term pension fund investors to recognise the positive virtues of investing a meaningful percentage of pension fund assets in property.
Internationally, we have noted that there is a trend towards fixed income investment and away from the volatility of equities. Property is starting to be considered as an alternative to the conventional bond markets. Will this trend impact on the pension fund decision makers when they ponder on asset allocations for 2004 and beyond?
This potential shift in emphasis away from the uncertainties of the equity market is largely due to a change in international accounting standards, particularly the advent of a rule called FRS17 that obliges all plcs to report the actuarial losses by their respective pension funds on their balance sheets.
As we move into 2004 the real risk facing pension funds is not being able to meet the pension promises to members. This is usually linked to final salaries, which it has given to its members who may retire in 20 or 30 years and may then live for another 20 or 30 years. In our view this is where property as an asset class comes into its own, characterised as it is by its long term secure income streams and its consistent record of producing reliable returns.
The IPFPUT distribution or dividend graph for the last five years demonstrates that an investor in our property pension fund would have seen their income grow by 60 per cent over the past five years and almost 19 per cent from 2002 to 2003. The fact that the IPFPUT income stream is underpinned by a rental portfolio that is two-thirds let to the State or blue chip tenants with an average of 12.5 years to run across all our leases underlines the stability of this income stream and supports the growth in the capital values of our properties.
Putting all your eggs in one basket, whether it is a basket of bonds, equities or property is risky. Pension fund managers have bet the house on equities while arguing that they would be deviating from their peer group (i.e. taking on more risk by not following the herd?) by having any more than 5-7 per cent in property. Marginally deviating from the ‘peer group’ in this respect over the last decade would have saved pension fund investors a lot of money.
Internationally, eminent commentators have pointed out that in these uncertain markets pension funds need more than ever to find true diversification. Their analysis underlines property’s power as a diversifier. This quality combined with the intrinsic value of a steady income stream and property’s quality as a hedge against inflation and partial hedge against deflation furthers the argument for a greater role for property in a well balanced pension fund. Recent surveys among pension fund investors in the UK confirm that investors would like to see a greater percentage of their monies invested in real estate with a preference to see weightings drift up to 20 per cent of pension fund assets
It might take a little longer for the penny to drop in the institutional pension fund sector but Joe public cottoned on to the real value of property as a pension fund investment a long time ago. Property’s favour with the private investor has intensified in recent years particularly given the number of people who were badly burned by the equity markets. In addition, the advent of self-administered pension schemes has heralded a real swing to property.
The underlying and stable income stream from property is what allows the private investor to borrow so readily. In recent years the yields from property have been significantly higher than the cost of borrowing.
Although this set of circumstances will not last indefinitely, this self-financing aspect of the asset clearly demonstrates that the exceptional quality of the income return provides a superb means of matching the liabilities of a pension fund.
Institutions point to the liquidity problem. The fact that transaction costs are significant and investments can be lumpy is seen as major drawbacks for pension fund investors. It could also be argued that for long term investors this liquidity draw back is often exaggerated given that pension fund investors can usually realise more liquid investments at short notice. Only funds that face sudden and large cash requirements will be discouraged by the liquidity argument.
Property has never been more widely held and traded in our economy’s history. A property put on the market at a sensible price in today’s market could quickly find a buyer. In addition, the increased availability of pooled property funds and property unit trusts allow the long term pension fund investor a greater degree of liquidity and access to a diversified portfolio of assets. These vehicles typically provide clearly defined entry and exit routes. All of this helps to bring institutional investment in property into line with other asset classes and to assist overall asset allocation and weighting.
So, if like so many pension fund managers today you were faced with an under-funded pension scheme would you take a fresh look at property or try to bet your way out of an unpredictable equity market? I believe that we need to restore balance. Balance the stable returns that over time have demonstrably accrued from property, with the more spectacular returns that traditionally have come from the more volatile equity markets.
We believe that the Irish property market continues to offer value for the long term investor. What we can say with some degree of confidence is that the Irish economy will continue to post solid growth rates over the next two to three years with the economy to remain at close to full employment assisted by low interest rates and low inflation.
We are optimistic that property will continue to offer growth prospects in such circumstances. We have forecast annualised returns to moderate over the next three year period to somewhere between 7 - 10 per cent per annum and in a low inflation environment we believe returns within this range will prove very respectable.
We believe that in order for a pension fund to provide the investor with a balanced return over the longer term property weighting levels should be in the range of 15-20 per cent of total pension fund assets. Otherwise investors disillusioned by the equity markets will continue to vote with their feet and take advantage of the property backed self administered pension schemes that will further increase in popularity if the proposals contained in the recently published Finance Bill are enacted. This will allow pension schemes to borrow directly for investment.
Niall Gaffney is the Investment Manger of IPFPUT.