The Wellcome Trust is a relatively young investor in real estate. This might come as a surprise to some, especially as it has been a trailblazer among UK institutions in investing overseas and indirectly.
The trust, the largest private medical research funding body inEurope with £11bn (e16bn) of assets, bought its first property in 1993. Now it owns more than £1bn of real estate,.
It has a directly held UK portfolio with retail, industrial and office property (but underweight in the latter) and a large residential portfolio. Around 15% of its investments are in continental Europe and held indirectly.
Head of property investment Peter Pereira Gray, who joined from UK insurer Prudential in 2001, has driven the trust to expand its portfolio and diversify overseas. “The portfolio has changed quite a lot in the past four years,” he says. “We have geographically diversified in order to take advantage of the different risk-return characteristics of property across continental Europe.”
Pereira Gray says he is “almost convinced of the intellectual case” to further geographically diversify the portfolios. The two markets most likely to be targeted are the US and Asia.
“The US is a large, mature, well-researched
English-speaking market. Asia, on the other hand, offers inefficient markets which can bring higher, if riskier, returns,” he says. He expects the trust to have invested in these markets within three years.
The trust’s aim is to generate high returns with acceptable risk, says Pereira Gray. “We have to fund our research grants and also protect future grants.”
In general the trust seems less risk-averse than most institutions – as a whole it is one of the world’s largest private equity investors and the real estate arm also invests in private equity and opportunity funds (see opposite pages).
Pereira Gray says the trust can afford to invest more innovatively than a pension fund, as it has the potential to control its spending, as well as its assets (ie it can opt to lower or raise its grants, whereas a pension fund has outstanding liabilities which must be served).
However, he says individual manager performance is still monitored as in other organisations. “We can perform away from the benchmark
for longer than other institutions, but questions will get asked if you underperform for a while.”
The trust is aiming to achieve long-term real returns of 6%, quite a steep target as equity
returns over the long term have been 5.5-6%. It pays out 4% of its smoothed asset base in funding each year.
Very strong performance from real estate investments both in absolute terms and relative to other investments has meant Pereira Gray has had backing to diversify the portfolio overseas and now to expand it.
A recent asset allocation exercise has resulted in the trust opting to increase its strategic real estate allocation, from ‘high single figures’ to ‘double figures’, with the aim of achieving this in two to three years.
In the future, real estate derivatives could be used to place this strategic allocation in the short to medium term. During his time at Prudential, Pereira Gray was closely involved in the UK real estate industry’s successful campaign to bring in legislation to make it possible for real estate derivative products to be developed.
Derivatives could aid the trust to re-allocate money from its large residential portfolio. Unusually for a UK institution, the Trust owns a portfolio of London residential properties, estimated to be worth more than £500m, which it bought in 1997.
“For example, we could sell index returns from this portfolio, thus freeing up money. And because we have a good management team, we would expect to outperform the index so still generate cash from the portfolio,” he says.
The residential portfolio, which has performed very strongly in recent years if not in the past two years in line with the London market, may also form the basis of a vehicle open to third party investment.
Pereira Gray says it could be sold into a fund open to third party investors but he would also hope the trust could gain value from the management team. “You could create a business that can then go out buying and managing new assets,” he says.
The trust is waiting to see the framework of UK real estate investment trust (REIT) legislation before it moves. A REIT could give a tax transparent onshore framework to get value for both assets and management. However, one thing Pereira Gray is clear about is that there are no current plans for the Trust to become a fund manager. “We are a very pure organisation,” he says. “We do not manage money other than our own.” An internally-managed REIT structure would seem then to be the ideal, as the trust could gain value for assets and management while remaining a pure investor in the REIT.
Pereira Gray thinks the current trend for real estate investors to move into fund management could lead to conflicts between fund managers and investors. “There is an issue here which industry undervalues. I believe there is a difference between an organisation which uses life fund or policyholder money to seed a vehicle which they then sell on to third parties and a manager who runs product for third parties without a ‘captive’ investor.
“I can’t help thinking that at some point this will run into trouble. You should have money from policy holders being run with their best interests in mind. But if that is being invested in a vehicle run by the same company which is there to make money for shareholders from fund management fees… at some point there has to be a problem.”
The Wellcome Trust - a strategy for Europe
The Wellcome Trust was one of the first UK institutional investors to make a significant move into continental Europe and investing in unlisted funds.
“If you don’t know an area or sector well, it makes sense to go in with the best management,” says Peter Pereira Gray. The trust now has 15% of its assets in continental European vehicles, about half-a-dozen of them.
The trust will almost certainly begin investing indirectly in the UK as well as on the continent, but only if it is the only way to get access to assets it couldn’t otherwise purchase and to get the best management .
“Otherwise it’s too expensive. Yes you get leverage, but that changes the risk/return profile. And in a vehicle you don’t have liquidity and you don’t have control,” he says. Pereira Gray is a member of the advisory panel of European unlisted vehicles body INREV, and is a keen promoter of investor involvement in unlisted vehicles.
“I try to be involved as much as possible and get to all the board meetings. I want the trust to be known as an intelligent investor and one that can add value,” he says.
Pereira Gray does not believe indirect investment is a matter of handing over your money to a fund manager and then sitting back and mutely reading a report every quarter. “I believe it is absolutely right and proper that investors take the lead – especially if they have knowledge and relationships that fund managers do not have. And you have to try to keep fund managers honest.”
Some of the fund investments are ‘straightforward’ actively managed funds such as Rockspring’s pan-European limited partnership, but Pereira Gray has also taken the Trust into Lehman Brothers’ real estate opportunity fund and into one of Pramerica Real Estate Investor’s private equity funds.Opportunity funds tend to be a step too far along the risk/return scale for most institutional real estate investors, but Pereira Gray says he has been impressed with Wellcome’s first investment.
Gray says: “You get a different type of investment approach: I like the mentality and philosophy and am constantly impressed by the quality of the individuals they employ and their intelligence dynamism, hunger and flair.”
Through Pramerica the trust invested in four European corporates involved in real estate: German developer Bauwert; UK self-storage firm Big Yellow, Belgian developer Banimo and UK developer Hemingway. The interests in Big Yellow and Banimo have been sold.
“The nature of the investment is different from buying a portfolio of assets,” says Pereira Gray. “You’re buying into a corporate with asset management expertise. With that and good assets should have better returns than if you just bought the assets, but obviously with an extra layer of risk.” He believes the European unlisted funds market will develop along the lines of the global private equity market, with a small but significant secondary market developing. Pereira Gray also believes both fund managers and investors will have a harder time on the future than in the past few years. “There’s been exceptional interest in real estate and rightly so. In a sense you haven’t been able to go very wrong in the last couple of years but over the next few years it looks a lot harder. You are going to see a lot of differentiation between vehicles’ performance and a lot of that is going to come down to the quality of the management team. “The flood of interest from institutions in the past few years has made it very easy for managers to raise money. But investors are going to have to invest a lot more carefully to secure returns so the best managers will end up with a following and the worst find it hard to raise money. We are spending more time thinking about manager selection and forming longer term relationships.”
Harder times over the next few years will create a greater balance between the weight of buying and selling money, says Pereira Gray. This will increase liquidity in unlisted vehicles and possibly create a more fluid pricing model.
“It seems strange to me that all stakes in real estate funds should be traded at NAV,” he says. “Why does that have to be the price? It doesn’t take account of management competency or that the vehicle might only have three years left to run. I struggle to see why many funds should not trade at a premium or discount to NAV depending on management or other factors.”