Combined property and bond mandates
Combined property and bond mandates are an interesting hybrid we introduced for some clients in the early 1990s, partly as a further diversification from equities and partly to improve the chances of better performance. Initially, these briefs were a combination of property and index linked gilts, but there is no reason why any class of bonds cannot be incorporated.
It can prove to be more difficult for specialist bond or property managers to add value within the single asset class, when compared with equity managers. This results from the characteristics of bond and property assets and the narrow nature of the mandates. However, combining the two assets in one mandate provides managers with the opportunity to out-perform, not only within the asset classes, but also from tactical asset allocation decisions.
In addition, it removes the need for trustees to make a conscious tactical asset allocation to property required by a pure property mandate. With the combined bond and property mandate, the trustees determine the strategic property allocation (ie the proportion included in the benchmark – normally accompanied by suitable control ranges). The short and medium-term tactical decisions are left to the investment managers who usually have greater expertise and day-to-day focus on markets.
The early experience of these mandates was a little mixed. The principal difficulty arose in the execution of asset allocation shifts between bonds and property. Often, managers would be able to identify opportunities for asset allocation gains, only to find that the property manager was not able to move quickly enough to make the most of such opportunities. This remains a feature where the property element is invested wholly directly. However, in recent years there have been considerable developments in indirect property (still to be really tested!). Special purpose vehicles, shared ownership and property index certificates have all combined to make indirect property investing a very much more attractive prospect than it once was. A by-product of these very welcome developments is a reduction, at least in theory, of the problems associated with asset allocation shifts in combined mandates.
Most of the managers that offer a combined bond and property mandate invest the indirect property element in both their own pooled funds and also with those of other managers. As well as reducing the risk by increasing the diversification in the portfolio, it improves liquidity and removes the need for the trustees themselves to make decisions on the range of property funds in which they want to invest.
Manager choice is somewhat restricted. Only a handful of managers have sufficiently good investment credentials for both bonds and property to merit inclusion on manager search short lists. The combined approach also rules out specialist managers who offer only one or the other asset class, or more generalist managers who offer both asset classes but are weaker in one than the other. This can result in very able asset managers being excluded from consideration, a reason why a combined bond and property mandate approach is not the ideal solution for all pension funds. We are also seeing the emergence of managers who specialise in managing combinations of indirect property investments for clients. These managers are only rarely found in houses that offer combined bond and property mandates.
Larger funds might combine a direct property portfolio utilising a specialist property manager with an indirect property manager running a portfolio of pooled vehicles and property instruments, operating under a combined bond and property mandate.
In this example, the asset allocator would be making the call not only between bonds and property, but also between the direct and indirect property exposure. An approach of this type, while seemingly complicated, might well offer the best of all worlds and perhaps should be the next development of this flexible approach to bond and property investing. We will be interested to see if there are any takers!
Geoff Singleton is a consultant with Hymans Robertson in Glasgow