Exploring new horizons
Finnish pension funds are seeking to increase their exposure to foreign property markets. But while their domestic investments in property tend to be held directly, forays into foreign real estate are more likely to be undertaken via indirect investment vehicles, they say.
The Tapiola Mutual Pension Insurance Company invests in property both directly and indirectly, says Investment Director Hanna Hiidenpalo. "Our direct real estate portfolio is domestic and we are diversifying the portfolio abroad using indirect real estate vehicles - both unlisted and listed funds."
Timo Sotavalta, head of real estate at the Etera Mutual Pension Insurance Company, says the company now holds about 10% of its assets in real estate. This is within the target allocation of 5-15%. Most of this - about 95% at the moment - is held as direct investments in Finland.
"Just now we are active in looking for foreign indirect real estate investments - in the EU or in Russia," he says.
As part of its drive to optimise the real estate portfolio, Etera's proportion of indirect investments will go up to 20-25% within the next two to four years, he says.
The Ilmarinen Mutual Pension Insurance Company has €2.2bn invested in real estate - which represents 10% of its total portfolio.
Mikko Räsänen, portfolio manager, real estate investments, notes that these investments are both direct and indirect, domestic and foreign. "However, at the moment our real estate portfolio is still heavily biased towards Finland," he says. Finnish property holdings make up 95% of the allocation.
"We started the implementation phase of our international real estate strategy - just indirect investments - two years ago," he adds. "To date we have made nine commitments, totalling €225m."
However, Finland's State Pension Fund - Valtion Eläkerahasto - has chosen to do all its property investment via the indirect route. "We invest in non-listed closed- and open-ended real estate funds," says portfolio manager Ilkka Tomperi.
Property has only become a part of the overall portfolio relatively recently. "Previously we had only equity and fixed-income investments and a decision was made a couple of years ago to diversify the portfolio further through other investments," he explains.
"The category includes indirect real estate investments, private equity and absolute return funds - primarily hedge funds," he says.
Currently the pension fund has a target allocation for other investments of 10%. Tomperi notes that as well as diversification, real estate provides decent returns compared to fixed-income and offers a hedge against inflation.
"The most import role real estate plays is as a portfolio diversifier," he says. "We also appreciate the return profile and especially the distributable income yield that real estate investments often provide. This helps with the J-curve of some of the closed-ended real estate vehicles and private equity funds especially."
The pension fund's indirect investments include non-listed closed- and open-ended funds and, to a lesser extent, listed real estate securities and REITs through mutual funds. Tomperi explains that the fund focuses on core and value-added strategies, although it might invest in some more opportunistic funds as well.
"At the moment the investment programme is diversified across Europe with a bias to larger Euro-zone economies," he says. "We haven't been active in the CEE area. About 20-30% of the current commitments relate to Finland and the share of listed real estate securities is about 15-20% of the invested euros."
Hiidenpalo believes that real estate is generally a useful asset class to have within a total portfolio. Apart from its low or negative correlation to equities and bonds, the cash flow it provides is valuable. "Core real estate investments provide relatively high and stable cash flow and a potential for capital growth," she says. "These are the very important features of this asset class," she says.
She also notes that listed investments in real estate sector such as the shares of real estate operating companies (REOCs) and real estate investment trusts (REITs), can be used as tactical investments. She points out that by using these instruments, an investor can take advantage of upside and upturn in selected real estate markets and sectors using market momentum and timing strategies.
Tomperi explains that the State Pension Fund has constructed its real estate portfolio to provide some distributable income yield right from the start. "Although the distributions can be quite low, they can provide some stability to the annual returns as well as make some room for more opportunistic investments," he says.
verall, the fund plans to build a well-diversified European real estate portfolio, taking in office, retail, logistics and other property sectors. "We also aim to keep the overall leverage of the portfolio below 60% as this is our sole route to the real estate market," he says.
Räsänen points out that at Ilmarinen, the real estate portfolio is optimised using an in-house Excel-based optimisation model, which the company developed itself, based on the principles of Harry Markowitz's modern portfolio theory.
Hiidenpalo sees a strong bias within property investment toward indirect investments through unlisted professionally managed funds, and that this is one of the main trends along with moves by European institutions to diversify their real estate portfolios both in Europe and globally.
But for the insurance company, she believes the real challenge of the moment is the sustainability of the pricing of real estate assets, "especially in the current environment of narrowing yield spreads."
Sotavalta points out that competition for good property investments is intense everywhere and yields are going down. "In the near future, it is going to be difficult to find good investments in European real estate market, and the risk level is going up," he says.
Räsänen also sees too much money chasing too few products. "The competition for the underlying assets is fierce also in Finland - hopefully the current pricing is at a sustainable level," he says.
"It's difficult to compete with international players given that we are not allowed to use leverage for our direct investments so it makes us difficult to increase, or even maintain our current real estate allocation," he says.