European pension funds expect to increase allocations to long-date index-linked income and real estate

AlphaReal, the specialist manager of secure income real assets, has commissioned a survey of European pension fund professionals who collectively oversee €324 billion in assets.

According to the survey, more than 70% of respondents say they manage their assets to an inflation-plus benchmark, with nine out of ten looking to surpass their strategic benchmarks by 1% to 3% over the long term.

The findings, outlined in a report entitled European Fund Survey, which can be downloaded for free at European Fund Survey – AlphaReal, reveals that 46% of survey respondents say their fund’s main strategic allocation priority is to increase diversification in the portfolio. This is followed by 28% who said it is to increase expected returns and 18% who cited it is to increase portfolio income.

The three main risk management priorities are to reduce absolute volatility of the portfolio, cut volatility versus liabilities (sensitivity matching), and to meet liability cashflows as they fall due.

The study found that many European pension funds allocate to illiquid assets to earn a premium above more liquid assets. Some 98% of the survey respondents say they have some allocation to illiquid assets, with nearly half allocating more than 10% of their portfolios in this way.

The survey also shows that European investors are demanding assets that can provide long-dated index-linked income, with more than half expecting to increase their allocations, and a further quarter of respondents expecting to increase their allocations dramatically. The survey also found that three quarters of investors expect a yield of 2.5%‑3.0% per annum from long-lease index-linked real estate assets, with a further 20% of investors expecting yields of 3.0% to 3.5%.

Phillip Rose, CEO of AlphaReal said: “Secure income real assets, such as commercial ground rents, could be an attractive option for European pension funds. In addition to inflation protection, these assets can also provide attractive risk adjusted returns for an investment grade asset. These characteristics have led to commercial ground rents growing to a circa £5 billion UK market in just over five years. We  see potential for similar growth in Europe with pension funds and insurers across the continent now evaluating this opportunity.”

AlphaReal’s research also revealed that ESG and real estate are key priorities for European pension funds. Nearly 90% of respondents expect to increase their focus on real estate over the next three years, while 88% say they will concentrate on major ESG issues over the same timeframe.

Colin Frearson, Client Solutions, AlphaReal said:  “In a world of higher inflation, many assets struggle to perform. Rising inflation may be a real threat to European pension funds’ performance unless they take steps to hedge their exposure. To protect portfolio performance, investors may benefit from assets that provide contractual, inflation linked returns.

These assets may also  aid diversification, reduce volatility and allow investors to de-risk without materially sacrificing returns”

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