Pension fund trustees should definitely be considering their weighting in directly held property, particularly in their post-retirement annuity portfolios, says Colin Young, head of asset management at the Old Mutual Property Group.

“Property as an asset class has excellent liability matching, diversification and duration extension attributes. We are seeing significantly increased demand from actuaries for property, “he says.

This follows years of reduced property holdings by institutional investors such as insurance companies.

Young says the level of institutional property holdings in South Africa today is  now growing from around 4%, down from 20% in the 1980s.

“Property returns in 2005 were even stronger than in 2004, with investors achieving a total return of 30%.  Strong occupier markets led to rental incomes rising faster than at any time in the last 10 years. That was coupled with robust investment demand pushing yields lower.”

Young says the market was led by industrial and retail property with the sectors each producing a total return of 33%.

“Offices again lagged the rest of the market although there are strong signs of recovery with vacancy rates falling sharply. “

He says the investment climate has been characterised by increased volatility of equity markets and a fall in fixed income yields. 

“There is pressure on matching liabilities because of changing demographics in many markets as a result of lower growth in populations and people living longer.  “

Young says UK research shows that duration is key to liability matching - and that long duration bonds have helped but these are in short supply.

“The decision is thus to compromise and reduce duration or to use property to increase it.

“UK research also indicates that if other asset classes are used to match liabilities, they should display enhanced returns, the ability to generate inflation linked cash flows similar to duration characteristics of the retirement fund, and capital values which have a high correlation with the discounted value of the fund benefits.

“Typically, balanced mandates have been used to enhance returns and to reduce risk. But it has been found in the UK that there is a migration away from balanced mandates. That is partly because falling interest rates placed a greater emphasis on liability matching and because falling equity markets and surpluses heightened the importance of asset allocation. “

Young says the positive attributes of property include its high running yield, the compounded effect of a growing income stream and its ability to enhance return relative to risk.

“It’s a tangible asset that isn’t swayed by everyday sentiment. The importance of its liability matching characteristics are not reflected in asset allocation levels at 4%. Its reliable, predictable growing income stream can improve liability matching duration. And in a declining or low interest rate environment, it offers excellent yield enhancement qualities.  “

Young says prospects for property are good.

“Economic growth is above the trend and expectations of above 5% growth for 2006 are conceivable.  Personal disposable incomes are growing at 11% and underpinning buoyant consumer spending and business confidence indicators are at record highs. “

He says supply of space appears to be constrained, with completion of buildings lagging behind approvals. 

“Vacancy rates are falling rapidly across all sectors and real rental incomes are growing at the fastest rate in a decade.”

“Given these factors, the recommended asset allocation to direct property for post-retirement annuity funds should be at least 20%, while for pre-retirement defined contribution funds it should be at a more modest 7.5% level. However, for pre and post retirement defined benefit pension funds, the allocation should be even higher.

“To cater for this demand, we will be launching an exciting new product in due course.”

Ends