Heading into 2016, it has been widely reported that institutional fund managers are looking to increase their allocation to real estate in order to better manage risk and the threat of increased market volatility. The question for SMSF trustees is whether they should be considering a similar move.
In many OECD countries, pension funds are the primary financing vehicles to fund retirement benefits. For the year ending December 2014, Australia had 16 funds in the world’s top 300 pension funds. While there are no Australian funds in the top 20, there are five inside the top 100: Future Fund, AustralianSuper, QSuper, First State Super and UniSuper.
In 2015, global pension funds across 19 major markets weighed in at approximately $35.4 trillion. Collectively, these funds account for around 35 percent of the institutional assets available to investors in world capital markets.
As a result, when global pension funds declare their intentions about where they intend to move and re-allocate money, market participants tend to sit up and take notice.
Institutions increasing allocations to real estate
In February 2016, Willis Towers Watson’s Global Pension Assets Study 2016 (GPAS) reported “allocations to alternative assets—especially real estate and to a lesser extent hedge funds, private equity and commodities—in the larger markets have grown from 5 percent to 24 percent since 1995”.
Taking this one step further, Roger Urwin, Global Head of Investment Content at Willis Towers Watson, noted, “Asset diversification into alternatives away from domestic equities has gained momentum among pension funds around the world as these strategies have helped to manage risk. The persistent economic uncertainty is likely to reinforce these shifts [because] 2016 has started with highly volatile conditions.” 
Similarly, in December 2015, Blackrock Investments polled more than 170 of its largest institutional clients, asking about potential changes to asset allocations in 2016. The findings showed 53 percent of institutional investors were looking to increase allocations to real assets and 47 percent will increase their allocation to real estate in 2016. By contrast, 33 percent and 30 percent of investors respectively will look to decrease holdings of equities and fixed interest. s
Managing risk and returns
Extracted from the GPAS, the chart below shows the movement in aggregate asset allocation by global pension funds for the 20 years from 1995 to 2015.
Chart 1: Asset allocation for global pension funds (1995–2015)
Several things stand out from this chart:
- Bond allocations have decreased by 7 percent in aggregate during the past 20 years (from 36 to 29 percent).
- Allocations to equities have fallen by 8 percent (from 52 to 44 percent) during the same period. (Interestingly, the study also revealed that, compared to other large pension markets, Australian funds have maintained the highest allocation to equities over time, reaching 48 percent in 2015.)
- The allocation to ‘Other’ assets has grown considerably over the period. The study defines ‘other’ as “especially real estate and to a lesser extent hedge funds, private equity and commodities”.
Perhaps the most illuminating aspect of the chart, however, is the willingness of global pension funds to evolve their asset allocation as they seek to manage risk and improve returns.
Whether or not an SMSF should be more active will depend on the circumstances of its trustees and beneficiaries. But, in an environment where global pension funds are clearly forecasting an increasing allocation to property in order to manage risk and returns, it may also be the right time to consider the case for commercial property as part of an SMSF portfolio.
The case for Australian unlisted property
The stock market's tumultuous start to 2016 has, for many, firmed up the case for considering alternative investment sources, particularly those looking for regular income.
What sets commercial property funds apart from other types of investment is that it can potentially deliver solid, sustainable and tax-effective income through periods of economic change.
One of the disadvantages of commercial property, however, is that it can be difficult for SMSFs to obtain exposure to it without having a very large balance. One solution is unlisted property funds, which may provide access to quality commercial property that can potentially deliver good income yield and capital gains.l
In addition, some of the other potential benefits of unlisted property funds include:
- Capital stability – Unlike share markets, where sentiment can be a large contributor to returns and values change daily, commercial properties are independently valued on at least an annual basis using a rational process that considers property and economic fundamentals. For this reason, direct commercial property values are typically more stable than their listed counterparts.
- Income distributions are principally made from the ongoing rental payments of tenants. By owning buildings that are leased to well known, successful companies, investors are able to indirectly access the growth of such companies. By way of example, nearly 70 percent of Australian Unity’s Diversified Property Fund’s rental income comes from listed or credit-rated tenants. Major tenants include Coca Cola, the Environmental Protection Agency, Myer, Woolworths, ANZ and Metcash.
- Commercial property rental agreements typically contain provisions for rental increases in line with inflation or increases by a set percentage each year. This goes some way to helping ensure investors’ income distributions grow in line with the broader economy.
For SMSF investors, an investment in an unlisted property fund can provide exposure to an asset class that, without a very large balance, would otherwise have been inaccessible.
Looking ahead, we believe Australian commercial property is likely to continue providing excellent yields when compared to overseas markets; and we also expect that strong investment demand from international buyers will continue. This will likely provide support to valuations across all property sectors.
In 2016, we believe that the big money just might be onto something—so we’re pleased to provide a range unlisted property funds that can enable SMSFs, even those with only modest balances, to invest.