The Rise of the Pension Fund Landlords | Chief Investment Officer

European asset owners should look to the UK residential property market for the next big opportunity in real assets, according to property managers.

A large demand-supply imbalance in the country’s rental market coupled with a recovering economy presents an attractive backdrop, the managers claimed, despite growing demand for physical assets and the strong long-term past performance of the UK market.

“The current opportunity lies in developing intelligently designed rental accommodation, which will be professionally managed and seeks to meet the needs of this growing population who need to rent,” Invesco said in a white paper.

Less than 5% of the UK’s private rented sector is owned by institutional investors, according to Invesco’s research, while the more mature US equivalent market is much more accepted as a viable asset class by pension funds.

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Between 1982 and 2014 both markets grew exponentially but the US has remained significantly larger than the UK for most of that period, data showed.

“The US index has remained at or around 10 times larger than the UK index over this timeframe,” Invesco reported. “Given that the US population is circa five times that of the UK, the UK index is significantly underrepresented. This suggests there is an opportunity for institutions to increase their exposure to the UK residential sector.”

Successive UK governments have been criticized for a lack of investment in housing, which Invesco’s research claimed would lead to a deficit of more than one million homes by 2020 if not addressed. The current government has promised to build 400,000 “affordable” homes by 2021.

In addition, rival property manager M&G Real Estate claimed in a recent outlook paper that the UK government was “trying to actively encourage” institutional investment in the residential market by excluding large-scale buyers from tax increases.

“This can only be beneficial for institutional residential investment prospects in the medium to long term,” M&G’s researchers wrote.

Growth of UK and US residential property markets

Terminating its hedge fund portfolio was the “best decision” the California Public Employees’ Retirement System (CalPERS) could have made, argued Fund Evaluation Group’s (FEG) Head of Institutional Investments Nolan Bean.

At FEG’s annual investment forum, Bean claimed that a $291 billon public fund like CalPERS has little chance of squeezing alpha from hedge funds. The number of managers necessary to justify a hedge fund allocation at a fund of CalPERS’ size can lead to a portfolio that’s over-correlated to equities, while disclosure requirements make it difficult to invest with the top managers.

“They’re subject to FOIA [Freedom of Information Act] requests,” Bean said. “Hedge funds don’t want to be subject to FOIA requests. The best hedge funds won’t take money from them.”

“As you have more managers, you basically become the market.”And having access to the best managers is especially important when it comes to hedge funds, which Bean argued have the highest performance dispersion of any other class of manager.

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“The reward is greater when you get it right, but the pain is also greater when you get it wrong,” he said.

Out of every 10 hedge funds, Bean estimated that at least six or seven weren’t worth investing in—meaning CalPERS’ program, which included 24 hedge funds and six funds-of-funds, had the odds stacked against it.

“As you have more managers, you basically become the market,” Bean said.

But just because CalPERS was right to dump its hedge funds doesn’t mean everyone should, he noted. With management fees dropping—the average is now 1.5%—investors are able to get a better deal than ever. For smaller, more private funds such as endowments and foundations, there is plenty to be gained, Bean said.

Not only are these asset owners more attractive to hedge funds seeking to avoid public scrutiny, they are small enough to invest with smaller managers—which Bean argued are usually the best performing.

“Attractive opportunities exist,” he said. “But manager selection is critical.”