Italian pension funds might swap Roman residential for overseas funds – if the regulators let them, writes Shayla Walmsley

Until relatively recently, two things were true of Italian pension funds investing in real estate. The first was a noticeable appetite for the asset class as a means of diversification. The second was a distinct desire to invest directly in their domestic residential market.

The first is still true. Italian pension funds currently have around €38.5bn invested in real estate. Combined, they account for 47.5% of the domestic property market. “We probably trust real estate more than we do equities or bonds or anything else,” says Claudio Pinna, head of consulting at AON Hewitt Italy.

The second has changed somewhat. More than 99% of pension funds still invest in their domestic property market. Yet the combination of a moribund domestic market – the first quarter of 2012 produced a single transaction – and greater appetite for indirect investment appears to be making an impact.

Giorgio Pieralli, fund manager at AXA Real Estate, which has so far raised €176m from Italian investors for a pan-European office fund launched earlier this year, points out that the domestic market is “completely frozen” as investors wait for price reductions.
“They want exposure abroad — but via a simple product that is easily understood,” he says.

Despite producing negative returns recently (-2.3% in the first half of 2012 and -4.8% over the past year), Italian real estate funds are strengthening their position. They include several funds set up by pension funds, invariably in joint ventures, open to third-party investors, and the negative performance coincides with a wave of consolidation, including Castello’s recent acquisition of RREEF Real Estate’s €500m Italian real estate fund business.

According to INREV, Italian institutions intend to increase their allocation to real estate from 6.9% to 7.5% this year (by comparison, UK pension funds allocate 6.6% and German pension funds 5.4%). Their exposure to directly held assets (including joint ventures) is almost twice that of their real estate fund holdings. All of the Italian institutions surveyed by INREV already invest in core funds, with 45% investing in value-added and 27% in opportunistic vehicles.

In some cases, they create their own. The €6bn Inarcassa self-employed engineers’ and architects’ scheme, which externalised its real estate portfolio as a fund in 2010, now targets a real estate allocation of 20% as part of its shift from defined benefit (DB) to defined contribution (DC) and a lower risk profile. CIO Alfredo Granata is targeting a minimum 5% yield on the real estate portfolio to 2014 by directing all new investments into the fund and taking minority shares in other real estate funds – including, potentially, overseas ones.

ENPACL, the labour consultants’ pension fund, which is bearish on the domestic market, is among other schemes that favour indirect investment. “Investing in well managed funds with a highly professional property manager in order to get good risk-adjusted returns looks attractive, while direct management looks quite inefficient due to low levels of management and lack of skill in selecting properties in a global market,” says Paolo Tosi, director of finance and assets at the scheme.

The problem with drawing general conclusions about Italian pension funds is that they fall under three specific groups, each of which is regulated separately and invests (or does not invest) in real estate in its own way. Sector pension funds – those set up to manage first-pillar contributions for specific groups of professionals – make up a €40bn market. Historically, with few limits on how they invest, these funds have invested up to 25% of their portfolio in real estate, says Pinna – but they tended to invest directly, in residential.

Private pension funds make up an €80bn market. But the rules are different for those initiated before 1993 and those established after. The older group – a combination of defined benefit and defined contribution pension schemes – have an allocation of 10-15%. The newer ones invest significantly less, not least because they are limited in how they can invest. With direct investment closed to them, they may invest in funds or not at all.

A new set of rules expected from the government could change how pension funds invest in real estate still further. The new rules have been in the offing for a long time – two years at the last count. Pinna believes that, when they eventually emerge, they will include few limitations on investment, whether in regulated markets or in alternatives.

“The big change will be in the organisation of pension funds, with a requirement that they perform risk-based analysis. In future, investment strategies won’t be connected to limits on allocations to specific asset classes but to risk,” he says.

In the meantime, some pension schemes are reluctant to invest in real estate.
Fondo Cometa, Italy’s largest pension scheme, hired financial risk consultancy MangustaRisk to draw up a theoretical portfolio including real estate in anticipation of new rules from private pensions regulator COVIP. That was months ago. Cometa is still waiting for COVIP’s promised investment guidelines to come into being before the board comes up with definitive rules.

Some schemes, such as ENPACL, have formulated their own investment strategies in the meantime. “We prefer not to wait for COVIP,” says Tosi.

But you can hardly blame those still waiting. “A lot has happened – but nothing useful,” says Davide Cipparrone, CEO of MangustaRisk. “Just as COVIP came up with a very well written document, albeit years late, parliamentarians came up with a proposal to abolish COVIP as part of a spending review.”

The regulator looks likely to survive. In the meantime, the government has a hefty incentive to liberalise existing investment restrictions. “Right now, the state needs to sell a lot of real estate assets. The question is whether it will prefer to sell them to pension funds – among the few institutions with money – especially in the absence of any other buyers,” says Cipparrone.

“The government doesn’t need to push pension funds to buy real estate, just to set the rules. But that could happen today, tomorrow or in 10 years’ time. This is Italy, after all.”