Rise From The Ashes
Judge’s comment: “Highly commendable, especially the relative performance versus peers. To move from bottom quartile to almost top quartile is a fantastic achievement.”
The €6.9bn Merseyside Pension Fund (MPF) has maintained a UK-focused direct real estate portfolio for many years which is managed on an advisory basis by an external strategic property adviser. In 2008, MPF identified that its real estate portfolio needed a drastic review.
The incumbent adviser had taken a strategic decision to move away from advisory mandates and, in addition, MPF had given the adviser a target to identify properties that provided a yield of 10-year government bonds plus 2%. This had been credible for many years but with yield compression it meant that the only properties that met the criteria were either low growth, over-rented or very secondary. The portfolio was blighted with voids and many leases were due to expire in the short to medium term. It also had a heavy bias to offices and was lagging its IPD benchmark.
MPF met this challenge heads-on in two ways. First, the benchmark was reviewed. Recognising that it is cash-flow positive and tax exempt, MPF decided that a total-return benchmark was acceptable and the yield requirement could be dropped. Second, the mandate was retendered and a second adviser appointed in 2009 with a brief to review the portfolio and re-shape it over time. MPF’s role is very much to co-ordinate activities between the two property advisers and the property valuer.
The new adviser categorised MPF’s properties as core, core plus and value-added. It also took the property values as a starting point and calculated individual property cash flows over five and 10-year time horizons. Rental growth and equivalent yield assumptions were applied to each asset as well as certain rent free, void and rental value assumptions. Properties were ranked by category and these projections assisted in identifying the potential to enhance returns further by actively managing or disposing of some of the assets.
Strategically, a decision was taken to reduce the overweight office exposure and increase the weighting to industrial assets, which were previously significantly underweight. Notwithstanding this strategic view, MPF also made opportunistic purchases of office properties. This led to the acquisition of some long-lease properties to rebalance the portfolio and extend the average lease renewal term.
As property markets recovered in 2011 and 2012, MPF found itself outbid on many opportunities by property funds and insurance companies seeking index-linked, long-term property assets. Although it still secured some suitable assets through off-market transactions and forward commitments, it shifted its focus to asset management. This led to the refurbishment or reconfiguration of many properties and their performance potential was enhanced and optimised.
MPF also used the recovery in investor confidence to dispose of properties with challenging no-vacancy situations and poor environmental performance as well as holdings with a small lot size that consumed a great deal of management time but that had limited impact on performance.
The fund is also in the process of undertaking its first property development, involving a long-standing shopping centre in the affluent town of Guildford, outside London. Previously, in such circumstances, MPF preferred to dispose of a property rather than assume the risk and disruption entailed in a large scale redevelopment but in view of its location in an affluent and busy UK retail street, it decided to commit to the project, which is expected to double its value despite the substantial investment.
The results speak for themselves and the fund has moved from the bottom of its peer group to the top within a couple of years. Over the last year, driven predominantly by income return as opposed to capital growth, the direct property portfolio outperformed the overall scheme benchmark by 0.8%, while beating its own benchmark over one, three and five years.
Merseyside Pension Fund
Founded in 1987
Defined benefit public sector fund
- active: 45,417
- retirees: 46,600
- deferred: 36,237
- one year: 12.6%
- Implementation of a total return benchmark
- Overhauled strategy and added second adviser
- Shift in focus to asset management and redevelopment
- Industriens Pension Denmark
- Lancashire County Pension Fund United Kingdom
- PenSam Denmark
- PGGM The Netherlands
- Edward Barker
- Douglas Crawshaw
- Stephan Kloess
- Richard Urban