In spite of the downturn, Swedish investors are increasing real estate allocations. But the focus is still domestic, finds Lynn Strongin Dodds

Some of Sweden's pension funds were beginning to take tentative steps outside their domestic market in the past year. The country had been holding its own in the credit crunch but the global financial meltdown in September and October, coupled with Iceland's troubles, has resulted in a freeze.

Market participants are concerned about Sweden's exposure to Iceland. Sweden's central bank offered a loan of up SEK5bn (€500m) to Kaupthing, Iceland's biggest bank, before it was taken into government hands along with  Landsbanki and Glitnir.

Christina Gustafsson, managing director of IPD Norden, says: "As in other markets, there is a lack of credit and it is difficult to find funding or refinance. We have already seen projects being pulled and new developments cancelled. The big concern now is Iceland. It is too early to predict the exact outcome, but there will definitely be an impact on the property markets. Investors are waiting to see what happens."

Institutions were already sitting on the sidelines, reeling from global financial misadventures in mid-September and early October. Although Iceland's struggles with a plunging currency and stricken financial services were well documented, many were surprised by the speed of the country's downfall.

In some ways, the situation may be déjà-vu for Sweden. Its own banking crisis during the early 1990s has some parallels with recent events. Sweden was forced to rescue its banks in 1992 after a credit and real estate bubble in the late 1980s. The government then gave a blanket guarantee for bank liabilities (excluding shares) and promised capital injections for troubled banks.

Charlotte Stromberg, chief executive of Jones Lang LaSalle Nordic region, says: "The crisis in the early 1990s is still very much a part of the Swedish institutional mindset. For the past 15 years, they have mainly focused on the home market and were reluctant to go down the international route because it had proved disastrous in the past. In general, though, when there is such turbulence, pension funds take a step back and look at the more liquid markets. They can take their time when looking at real estate investments because they do not have to act straightaway."

Kristina Najjar, head of business development, Sweden, for Aberdeen Asset Managers, agrees. She says: "It is still early and although pension funds will rebalance their portfolios I do not think they will change their asset allocation or strategies to real estate. Property is still seen as an efficient diversifier that reduces overall risk and generates steady cash flow."

For example, SEK33bn Kåpan Pensioner (the Swedish Pension Insurance Society for Government Employees) has recently applied a new investment policy that raises its asset allocation to alternatives such as property-related products, hedge funds and commodities  to  around 19% of the scheme's total investments. Kåpan is waiting, though, for the markets to stabilise before making further decisions on the specifics.

The SEK13.6bn Postens Pensionsstiftelse, the pension fund for the employees of the Swedish post office, has also increased its exposure to alternatives, including property, in line with its long-term strategic plan, according to industry reports. Real estate now accounts for a 9% slice of the portfolio, up from 7%, while infrastructure has jumped to around SEK87m since the end of last year. Overall, the mix is 50% in fixed income, 19% in equities, 18% in hedge funds, and a respective 2% in infrastructure and private equity. Further increases are expected later.

"There has been a lot of talk about going abroad but so far I am not aware of that much activity," says Joen Siggelin, a partner at Scius Partners. "On the whole, Swedish pension funds still invest directly and on their home turf. This is because many have large in-house teams that have a lot of property management expertise in their home market. At the moment, though, against the current turbulence, there has been little activity. There are still buyers but sellers still have high price expectations and there needs to be a better balance."

The one fund that has ventured abroad is AP 3, the Swedish national pension buffer fund, which has already made its first commitments to indirect international property. Previously, the fund had only invested in property through the AP funds' co-owned property firm AP Fastigheter. Christina Kusoffsky Hillesöy, communications manager, says: "Our aim is to have a well diversified portfolio.

Real estate is effective from a risk diversification perspective, which will help us to stabilise our total fund return. Our long-term expected return is 10%, which is appropriate considering the risk level. We are therefore mainly looking at core/core plus type of funds and this applies to all geographies.

"We are still building the portfolio and the ultimate aim is to have half of the real estate invested in foreign property. We are investing through indirect property funds abroad and our target is to have one-third in Asia, one-third in Europe and one-third in North American properties."