This article appears courtesy of Institutional Investor
Source: Global Money Management
European pension funds are set to increasingly use derivatives in their real estate portfolios as they become more aware of disadvantages to direct property, said Nick Tyrell, director of research at JPMorgan Asset Management's European real estate team. Currently, real estate accounts for just 6.5% of the average pension fund portfolio in Europe, according to a recent JPMorgan study.
Low liquidity, tax inefficiency, high management costs and high exposure to asset risk are all disadvantages of investing in direct property or through a closed property fund that pension funds are well aware of. As a consequence, Tyrell expects pension funds to slowly adopt derivatives in their real estate portfolios through semi open-ended property vehicles. Derivatives can be open-ended in the sense that there is no limit on how much an investor can hold, so long a counterparty can be found to write a derivative contract, he explained.
Relative to direct investment, derivatives deliver up-front liquidity, avoid property transaction costs and the asset management costs are low, Tyrell added. The semi open-ended fund model has been in place in the U.S. for the last 30 years, but it is a new initiative in Europe and he believes it will be progressively more used among European institutions as "investors are increasingly seeking reasonable returns at moderate risk."