Are pension funds still too light in property?

04-05-2005

Since the pension fund of Boots, the UK equivalent of Clicks, moved its assets entirely into bonds, reports have been surfacing of an international trend among pension fund managers of abandoning active fund management in favour of a safety-first approach that depends on bonds to provide a sufficient return to meet their future promises.

Rode’s Report editor Garth Johnson notes that if this is so, a strong case can be made for greater investment in property by pension funds, whether directly or indirectly via listed funds. While listed property might be a slightly more risky investment option, it has an added advantage over long bonds in that it offers the chance of higher returns.

The similarity between property and bonds is evident from the close correlation between the dividend yields of listed funds and bond yields since 1998. Moreover, according to Rode’s Report, listed property and bonds are viewed as similar for two reasons:

Firstly, a listed portfolio is, in one sense, nothing but a bundle of contracts, which by their nature lend a strong degree of predictability to future earnings. Secondly, it is a fair assumption that the cash flow of listed property will grow — in contrast to that of bonds. Thus, the risk and growth prospects tend to cancel one another out, and investors, therefore, see them as close substitutes.

Johnson suspects that some pension fund managers might dither too long and find themselves eventually acquiring property pro-cyclically instead of counter-cyclically.

He refers to the many pension funds that dumped stocks in the mid-1990s, just as the office market’s long real-rental cycle passed its trough in 1995. This strategy turned out to be pro-cyclical, in that real market rentals started growing as the upswing phase of the long cycle had started at about the same time.