Property Will Become a Bigger Pensions Play

This article published with permission from FT.com.

Pension money is not necessarily smart. Far from it. But the flows of money controlled by retirement funds are so huge that it behoves everyone else to take notice. And that implies that, for the foreseeable future, all investors should be paying attention to asset classes like real estate and infrastructure.

That is the implication of the latest research on global asset allocation produced by

Amin Rajan

of

CREATE-Research

for

Principal Global Investors

. After interviewing pension fund managers and high net-worth investors across the globe, he reveals that the structural factors driving institutions into assets like real estate are overwhelming, and likely to persist.

This is not merely a restatement of the familiar problem that both stocks and bonds look expensive. Demographic factors leave pension funds facing an imperative to buy different, higher-yielding assets.

Let us start with defined benefits pensions. They are in decline as companies tell employees to bear the market risks. And the demographic cycle is turning against them. Some 20% of their members are already retired but the largest cohort of postwar Baby Boomers will retire between now and 2020.

Faced with these difficulties, their greatest priority is just to meet their liabilities. They are prepared to forgo some "upside". Hence,

Mr Rajan

found, these funds have, since the crisis, been looking for assets with bond-like features that have a low correlation with traditional asset classes.

That means three asset classes have seen particularly sharp increases in interest since 2012: real estate, infrastructure and alternative credit.

Real estate, in particular, has the potential to be taken much further. In 1974, property accounted for 20% of all the assets held by

UK

pension plans (at that point overwhelmingly run on a defined benefits model). By 1999, this had dropped to 3%. It has now recovered to 8% with managers projecting that this proportion could rise to 11% by 2017.

Meanwhile, high net worth investors, who did very badly in 2008, are changing their approach. They are looking for absolute returns and for regular cash flow - and real estate has emerged as their most favoured asset class, having risen sharply in popularity since 2012. Now that their priority has shifted to preserving their capital, so their asset allocation has changed, and they are looking increasingly at property.

This rings some bells. In the 1990s, the demographics of the time helped drive a similarly clear-cut asset allocation. At that point, as baby boomers were approaching retirement and putting money away desperately in an attempt to bolster their pensions, structural factors overwhelmingly favoured equities. Even as the great bull market of the 1990s tired, several sharp corrections were treated as "buying opportunities" by boomers desperate to make a return.

Any analogy with equities in the 1990s should raise some concerns. We now know that that ended with an epic crowded trade in dotcom and other technology stocks. The merest glance at

London's

skyline, and in particular at the number of cranes appearing across the city as construction continues unabated, shows that there is good reason to fear a crowded trade in property. And if it was hard to exit tech stocks in a hurry, pulling money out of property or infrastructure developments would be far harder.

The desire to seek out assets because they are uncorrelated should also ring some alarm bells. When assets are not correlated to stocks and bonds, it is usually because they have historically been held by different investors, for different reasons.

The experience in the middle of the last decade, when investors ploughed into asset classes such as commodities and emerging market equities on the assumption that they were not correlated with developed market equities - only to find that they crashed even harder once the crisis broke in 2008 - is instructive.

There are risks when structural factors force money into new asset classes, which many investors may not understand. But the pressure to invest in property or infrastructure is unlikely to abate for many years.

john.authers@ft.com