Søren Schjødt-Hansen

Finanssektorens Pensionskasse

In Denmark too, pension funds are able to take on debt directly in portfolios for investment purposes, and Finanssektorens Pensionskasse takes advantage of this freedom in its property investment.

"We have debt both in relation to the funds, and in the main portfolio," says Søren Schjødt-Hansen, chief investment officer at the €3bn industry-wide Danish pension scheme. Borrowing not only enhances the potential for returns, but also helps secure the value of the real estate portfolio, he says.

FSP has not publicly disclosed the overall level of gearing in the real estate portfolio. But within its indirect property investments, the gearing ratio is generally between 30% and 50% at the moment, although they are able to gear by up to 65%.

Schjødt-Hansen explains that the pension scheme first took on borrowing in this way in 2005, following a study into the projected outcome of such a step, and that there were a variety different reasons for gearing up, he says. "We put it in at a fixed rate, partly to secure some of the value we already had in real estate, as well as possibly to broaden out the investments we already had," he says.

Before the portfolio revamp in 2005, 90% of property investments were held directly, but now the direct/indirect split is 60/40, he says, adding that all of the direct investments are within Denmark and a quarter of the indirect investments are also domestic.

It was a big change for the pension fund when, in 2005, it began taking on loans in direct property and investing in indirect vehicles, says Schjødt-Hansen.

However, its UK property exposure - which had made up all of the 10% it invested outside the domestic market - had actually been using lending since the mid 1990s, he says. "Our investments in this exposure have been structured as stocks in a property company," he says.

He explains that property has been an important component of the pension fund for a long time. "For many years it has been, since returns have been attractive and it has been the best asset class since 2000," he says.Schjødt-Hansen acknowledges that the low short-term interest rates over the last few years has strengthened the argument in favour of leveraging property portfolios, especially in indirect funds, but this might not always be the case.

"That might be changing since yield curves are flattening," he says, adding: "We would take this into consideration when deciding on the appropriate level of debt."

He believes that debt in a portfolio does not necessarily increase risk. "Some of the risks work against each other," he says, pointing out that taking up the loans was partly a strategy for securing values.

Schjødt-Hansen explains that in Denmark, the authorities look at the total risk of a fund, rather than whether or not it has borrowings, "So you can do things you could not do before," he says.


Leonor Machado

Banco de Portugal

Regulations governing pension fund and insurance company investment in Portugal stipulate that borrowing may not be used for direct investments, according to Leonor Machado, head of the real estate market unit at the Lisbon-based Banco de Portugal pension fund.

She explains that borrowing is not allowed in any of the pension fund's portfolios. Could pension funds reap higher returns on their property investments if they were able to use gearing? "It's always a balance between risk and return," says Machado. "It all depends on the situation."

Banco de Portugal pension fund has total assets of around €1.2bn; its allocation to real estate assets is around 14%. Although there is no direct gearing to improve the return potential of the pension fund's property portfolio, some of the indirect investments it holds - real estate funds, for example - do have debt of their own, in accordance with the law and regulations.

"In real estate, it is very common for funds to use debt to get the best results," says Machado. "We invest in real estate funds, so we do have leverage indirectly. "When it is used efficiently, it can improve results," she says. However, there is always a risk with gearing, particularly in the current economic climate in Europe where interest rates are expected to rise."

Machado explains that in a leveraged property fund, the opportunity cost of the capital increases when interest rates rise; gearing puts extra pressure on the real estate investments to perform, because they need to generate enough return to cover the interest on the debt.

She points to the issue investment delays can always happen where there are construction projects. "But if you have a long term investment horizon, then it is not necessarily a problem."


Patrick Kanters

ABP Investments

In the Netherlands, there is no regulatory bar on pension funds taking on debt as part of their investment strategy. ABP Investments has leverage in almost every company, according to Patrick Kanters, managing director real estate of ABP Investments. "Some assets have more leverage - private equity, hedge funds, strategic real estates - and this is part of their risk/return profile," he says.

In some countries, it is only through indirect property investment that pension funds can hope to cash in on the higher returns that leverage may generate. But since Dutch law allows pension funds to gear their investment portfolios directly, they have no such incentive to invest indirectly. "We invest indirectly because it enables us to diversify our investments globally, align ourselves with the best managers and broaden our opportunity set," says Kanters.

ABP, which has assets of €200bn, has about 11.5% of its net asset value in real estate, with 65% in the listed market and 35% in non-listed funds.

Kanters explains that each of the funds uses leverage as part of its strategy, style - core, value added and opportunistic - and country. "On average, our gearing ratio is 40% for Europe, 50% for Asia Pacific and 60% for North America," he says, adding that some more opportunistic plays have more than 80% loan-to-value.

"The low interest environment, combined with the good real estate returns means that leverage has had a positive impact on returns," he explains. "But again it should be handled prudently in relationship with strategy, style and specific capital market structure and by operating a meaningful debt policy."

Addressing the question of the interest rate risk inherent in gearing property portfolios, Kanters says that almost every fund partly hedges its interest rate risk.