Does a £4.7bn UK real estate fund merger reflect an existential crisis?

Last week, L&G and Federated Hermes merged two long-standing UK real estate funds – dating back to the 1960s and 1970s – to create a £4.7bn (€5.43bn) vehicle. Consolidation is common phenomenon in real estate fund management, but this particular merger – between the Federated Hermes Property Unit Trust (FHPUT) and the L&G Managed Property Fund (MPF) – is arguably a sign of the times.

According to one consultant, UK institutional property funds face a hard prospect of “evolution or extinction” against the backdrop of changes in the profile of the UK pensions industry. Institutional real estate fund managers traditionally relied on defined benefit (DB) pension schemes. But the long-running decline of DB capital has accelerated in recent years and has not been adequately replaced by the growth of defined benefit (DC) pension funds.

Consolidation therefore seems almost inevitable in this environment. But it is not easy. “This is a landmark transaction,” says Mark Russell, CIO of Federated Hermes Real Estate. He tells IPE Real Assets: “These transactions don’t happen very often. There have been others that have been attempted and have not succeeded for various reasons.”

Russell, who joined Federated Hermes in 2024, previously worked for a decade at L&G and ran the very fund which is now subsuming the other. He therefore understands both funds well and says that, while their portfolios are unique, in terms of geographic and sector weightings, income profiles, void rates and “all the sort of characteristics that one might look at in a core/core-plus portfolio, they’re pretty similar”.

FHPUT dates back to 1967 and Hermes (which became Federated Hermes in 2020) took over the management of the fund in 2001.

Over the 24 years since then, returns have comfortably exceeded the benchmark by 1.4% per annum, Russell is keen to point out. But despite this outperformance, “it was clear early on that”, Russell admits, that “our own involvement in this mandate would be coming to an end”.

Russell says FHPUT’s investor base was dominated by DB pension schemes. “Many such schemes are better funded in the environment of higher risk-free rates and that’s led to allocations away from risk assets such as real estate,” says Russell. “That is something that we’ve seen across the market. We’ve seen other peer funds experiencing similar redemption pressures. I think it’s fair to say that we thought we’d navigated our way through most of that, but when a further significant redemption request was made that threatened to destabilise the trust, we looked at alternative options.”

The default option would have been a protracted wind down, selling assets in an orderly manner. But Russell says that “investors were telling us that they did not want to be selling assets at this low point in the cycle”. He adds: “We felt that a wind down would be a sub-optimal outcome for them.”

L&G’s MPF, meanwhile, has been enjoying net inflows from a “large DC investor”. Russell did not identify the pension fund, but it is known that the £49.7bn government-established Nest is an investor in L&G’s Hybrid Property Fund, which itself invests in MPF. It was in this context that Federated Hermes alighted on the L&G vehicle as “being a fund that was similar in philosophy, similar in portfolio composition, but was larger and was in receipt of net inflows driven by a large DC investor”.

And the significance of the size of the L&G fund should not be overlooked. At the end of 2024, MPF was about four times the size of FHPUT, at £3.75bn and £856m, respectively. “There is a perception in the market that if you are below £1bn then you might be vulnerable to redemptions potentially destabilising the rest of the fund base,” Russell says.

Existential crisis: evolve or go extinct?

The demise of UK DB pension funds has long been trailed. The vast majority have long been closed or have even been effectively offloaded through ‘pension risk transfers’ and ‘buy-ins’ with specialist insurance companies. The Liz Truss government’s ‘mini budget’ of 2022, which caused government-bond markets to plunge, accelerated the trend.

The UK real estate fund management industry, long reliant on DB pension funds has been pinning its hopes on DC pension capital. They have launched Long-Term Asset Funds (LTAFs), which were recently introduced to funnel DC capital into illiquid assets like infrastructure and real estate. But such efforts have not been able to keep pace with the decline of DB capital.

“There is a fundamental change underway in UK pension capital,” says John Forbes, the veteran UK real estate funds consultant. “This has been happening for some time, but was massively accelerated by the liability-driven investment (LDI) crisis following the Liz Truss mini budget in 2022.

“Corporate DB pension provision is disappearing and being replaced by DC pension provision. Investment managers need to adapt to this, and some funds are better able to do this than others. The transition is also taking time, so there is a capital gap.”

Where DB pension fund capital is growing is within UK local government pension schemes (LGPS), which in recent years have been consolidated in eight ‘pools’ and could see even further concentration in the future. But this consolidation means that LGPS funds are “less inclined to invest through traditional funds”.

The upshot, Forbes concludes, is that UK real estate funds “face evolution or extinction”.

LTAFs might hold some of the solution. But for the incumbent investment houses that manage endangered UK property funds, there are decisions to be made. “Institutional investors increasingly want to invest with specialists rather than generalists at the real estate level,” says Forbes. “As a manager do you want to manage an LTAF or do you want to be the specialist into which other managers’ LTAFs invest?”

As for Federated Hermes, Russell says: “We will continue to run other investment management mandates, and we are working at the development of new investment solutions appropriate to clients’ needs.” The focus will be on where “we see significant opportunities to address long-term structural undersupply in sectors where occupational demand is non-discretionary,” he says. “We will be demand-led.”

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