RECENT observation by Insurance and Pension Commission on investments into properties, should nudge fund managers to think about whether they are creating optimal value for pensioners.
The remarks by IPEC commissioner Tendai Karonga, corroborate what Finance and Economic Development Minister Patrick Chinamasa, had previously said when expressing concern about the value of investment choices of the National Social Security Authority. The minister voiced concern about investments that created little value for pensioners who toil to make contributions over their working life, but get disappointed by the little benefits they receive on retirement. Pay outs are a function of returns from long time investments.
While investment in property makes sense, what should be interrogated further is the value created by the investments and what other choices the fund managers have to sweat their asset holding portfolios to create liquidity and sustainable value for policy holders. According to IPEC, the insurance and pension sector has over $1 billion worth of assets in properties, but this huge asset base might not create significant value for the contributors if not properly invested.
While investment in property is prudent, returns are currently not encouraging due to the challenges the economy is facing. Comm Karonga said a drive around most CBDs reveals that the occupancy rate of most properties is very low at well below 50 percent and the question is the extent to which fund managers are going to transform safe haven property investments to star performers.
"This situation is compounded by the fact that selling commercial properties in the current economic environment is very difficult given liquidity constraints in the market," Comm Karonga further noted. In a bid to enable pension funds to unlock small parcels of liquidity from their commercial properties, it is critical that the capital market players develop Real Estate Investment Trusts," he said.
Given this scenario, Comm Karonga said Real Estate Investment Trusts result in indirect ownership of properties through shares whose value is based on the value of the underlying property.
Where a pension fund has a liquidity need, instead of selling the whole property, which is difficult given the prevailing economic environment, the same fund would only need to sell a small parcel of shares with a value corresponding to the liquidity need, Comm Karonga said. By so doing, a fund would have met its liquidity requirements without having to sell the whole underlying property and keep unit prices of an otherwise huge investment in property at current market rates.
Many large pension funds and insurance companies, especially in the United States and other western economies are looking to increase allocation to real estate, which can offer both income and upside. Most of this investment in real estate, historically, has been in private equity real estate funds, or in direct ownership of bricks and mortar.
Investment in real estate investment trusts by these large companies has been slightly lower. However, pension funds in the US and Europe are beginning to realise that by diversifying real estate allocations to include more REIT stocks, they can increase liquidity and returns, and decrease volatility.
"There are a variety of reasons why REITs outperform private real estate," says Brad Case, vice president of research and industry information of the National Association of Real Estate Investment Trusts (NAREIT).
"It's not entirely because of fees and expenses that REITs offer better returns, but the fact is that you'll pay about half a percentage point a year to a manager of a REIT portfolio, but 1,1 percent a year to the manager of a core real estate fund and nearly 2,5 percent to an opportunistic fund. Even more important is the difference in the business models. If you invest in a private fund, the managers have to put that money to work immediately, so they might have to buy assets at the top of the market, which is the worst time to do it. At that same time, at the top of the market, REITs might be selling, because their investors are only buying stock: not demanding that the REIT uses their money to buy property," Mr Case said.