The debatable alternative
Poor relative performance, a lack of quality market information and the hassle factor of owning property has seen the weight of property in European pension fund portfolios fall dramatically over the past 20 years. As a result of this property has moved from being a mainstream asset class to an alternative asset class.
Alternative asset classes to bonds and equities are expected to achieve either returns in excess of equities or to diversify away from equities and reduce the volatility of the entire portfolio. Property can and does meet these requirements. Property returns have very little correlation to those from equities and bonds. Property holdings therefore reduce the volatility of the whole investment portfolio.
The need to find alternative non-correlated assets are increasing as equity market becomes increasingly volatile. Equity markets around the world have also become more highly correlated and so the diversification benefits of cross-border investment have been reduced.
Performance prospects are also very good. The current pricing of property relative to equities and gilts looks very generous and property looks set fair to give the mainstream asset classes a run for their money.
With its high-income return and growth potential property currently looks very attractive and suggests that there is a place in the portfolio for property, not just as an alternative but as a mainstream asset class.
However, a major concern for investors has been how to access the market. Property is perceived as illiquid and many pension funds have dismissed property, taking the view that too large a sum is required to hold a fully diversified portfolio. Tactical allocations are also difficult to implement given the time it takes to buy and sell real property
However, in the UK and in the Netherlands pension funds have realised that by investing indirectly they can overcome many of the concerns about how to invest in property and get access to the income, lower volatility and diversification that they are seeking.
The use of co-investment funds provides risk management through more fully diversified portfolios, better property management by the use of specialist, focused managers, access to larger properties, reasonable price transparency and more liquidity. Combined with better return expectation property is firmly back on the pension fund asset allocation agenda.
There has been a burgeoning of new vehicles and methods of investing in property indirectly. It is the indirect revolution that is making all this possible and as asset allocations to property are raised then the recent designation of property as an alternative asset class may well be set to change.
Lack of market information and transparency is also a deterrent to investors from holding a property portfolio. However, this is changing with a growing number of European countries now producing accurate market and performance data.
In the UK the service is most advanced with accurate market statistics from the Investment Property Databank (IPD) available back to 1971. The RoZ/IPD Netherlands Index was launched in 1994 and represents 85% of the value of the holdings of the financial institutions and quoted property companies in the Netherlands. In Sweden the SFI/ IPD Index was launched in 1997 and represents 50% of the value of the holdings of the financial institutions and quoted property companies in Sweden. In Ireland the IPD/SCS Index covers the period since 1984 and 85% of all institutional investment in the Irish market.
In total, accurate investor indices are now being produced in eight countries and new indices are being constructed in Denmark, and Spain, Portugal and Belgium and a new deal have been struck in Finland.
The ability to have a property benchmark across Europe is vital to promote cross border property investment, particularly for European funds.
The final barrier to property regaining its mantle as a mainstream asset class is the lack of derivate instruments. However, with the growth of representative and authoritative market indices this looks likely to change.
Already in the UK Aberdeen Property Investors has launched Property Index Certificates that provide index-based returns based on the IPD UK Annual Index.
Anne Lucking is director and Malcolm Frodsham is research manager at Aberdeen Property Investors