A liability-driven investment strategy built on the UK property markets could provide institutional investors with the kinds of returns that will help to match long-term obligations and manage risk, according to a recent report from Pramerica Real Estate Investors. Pramerica is the European arm of Prudential Financial, Inc.'s real estate investment management and advisory business.
The recently released report uses the Investment Property Databank UK Annual Index to highlight the relative strengths of commercial real estate in meeting liability risks for an institutional investor.
To date, most LDI portfolios focus on cash, bonds and equities, with little emphasis on commercial real estate, according to the report, Developing a Liability-Driven Investment Strategy for UK Commercial Real Estate. The primary case for investing in UK property, according to Pramerica, emanates from the relative stability and security of real income returns and from the benefit of providing diversification to investment portfolios.
From analysing the relative risks and returns across different property types, Pramerica created a model property portfolio for an LDI strategy that, when compared with the IPD index over 27 years, performed better than the index in almost all measures. The optimal portfolio delivered a relatively lower variance (3.8% for the optimal portfolio versus 7.3% for the IPD) for broadly similar returns (6.8% for the optimal portfolio versus 6.7% for IPD). The optimal portfolio had more security of incomethe average lease length in the optimal portfolio was 12.2 years compared to 11.2 years for the IPD. Inflation hedging was also higher in the optimal portfolio, given the goal of minimising the variance in real returns.
Peter Hayes, Director of Research for Pramerica, commented: "There is a compelling case to be made that an LDI strategy in UK real estate can benefit investors looking to match long-run liabilities. Commercial real estate produces stable, long-term real income returns with both inflation-hedging and diversification benefits, which can help investors to manage risks and earn excess returns.
"The case is even stronger when we consider the current and expected future performance of the income returns on property in the UK. Relatively high income returns are expected to persist for several years and could help investors rebuild capital bases and repair balance sheets."