A new report by Professor Graeme Newell finds Asian pension funds under-allocated to real estate and in need of reform. An overview of the report and a summary of findings is presented by Peter Mitchell

"Major demographic changes in Asia will see Asian pension funds reassessing their current conservative asset allocations. Increased levels of real estate in their portfolios offer an important asset class for Asian pension funds to achieve portfolio diversification and meet their significantly increasing future liabilities in an effective risk-adjusted manner." This was a conclusion of a report on Asian pension funds' real estate investment activities and strategies by Professor Graeme Newell of the University of Western Sydney.

Asian pension funds are a potentially significant source of capital for real estate in Asia, but typically have low allocations to real estate. Current allocations vary widely, with the largest pension fund in Asia (€0.93trn) having no allocation to real estate at all.

In some countries, regulations prevent greater investment by pension funds in real estate. Most Asian pension funds have 70-80% allocated to fixed income. There is a need for a greater understanding of Asian pension fund investment in real estate and there is insufficient information available. Development of a comprehensive understanding of Asian pension fund investment in real estate, including an understanding of policy positions and regulatory constraints, will enable development of a considered strategy to encourage greater investment in real estate. To date, a lack of research work and coverage have made it difficult for the industry to understand their thinking.

The level of real estate market maturity in the region differs from country to country and the level of sophistication of investors' attitudes to real estate also varies. Traditional superannuation funds are one of the major sources of capital in the real estate investment markets in Australia and New Zealand, which has been a significant influence on these markets being among the most transparent in the world.

In other parts of Asia, however, pension funds are relative newcomers to investing in real estate markets and some of them have virtually no allocation to real estate investment due to regulatory constraints and/or unfamiliarity with this asset class. A lack of institutional-grade property in some of these emerging markets has also been an impediment to domestic real estate investing by Asian pension funds.

With the strong growth of REIT markets in the region over the past few years, some pension funds have started investing in REITs through their existing equity exposure. However, as a result of the financial crisis some funds have been concerned that in the short term some REIT markets have been highly correlated with general equity markets. As a consequence, some are moving away from REITs to direct real estate investment or lowering their allocation to real estate. As pension funds play a major part in the evolution of real estate markets, it is important to identify their investment trends and promote the benefits for pension funds investing in real estate, both public and private.

Asian real estate would benefit from greater investment by Asian pension funds in many respects, including:

• The encouragement of a continental market for real estate in Asia;

• The reduction of Asian real estate markets' reliance on foreign investors and direct exposure to global financial and property cycles (through a more diversified base of local long-term investors);

• The promotion of efficiency and transparency of local real estate markets through the involvement of strong powerful players (eg, corporate governance); and

• The generation of new sources of funding for Asian REITs.

In addition, Asian pension funds will benefit from Asian public real estate securities as reliable revenue-generating assets, which would be highly beneficial to policy holders.
The research involved surveys of major Asian pension funds, interviews with leading real estate industry figures and sourcing of a range of data including pension fund annual reports.

Key findings
The report addressed the current under-allocation to real estate among Asian pension funds; why real estate must, however, take on significantly increased importance; and how leading Asian pension funds are effectively increasing their real estate exposure. It concludes with effective strategies for increasing real estate allocations by Asian pension funds.

With Asian pension funds to see significant growth in their assets under management, to over US$4trn (€2.8trn) in the next decade, key findings of the APREA report include:

• Global context to pension funds and real estate investment: Globally, pension fund assets have increased from $17trn in 2001 to $30trn in 2010. Real estate has been an important asset for pension funds in many countries because of the investment characteristics of high quality, income-producing real estate and its low-risk and portfolio-diversification benefits.

• Context to pension funds in Asia: Asia has some of the largest pension funds globally - eight of the top 20 largest global pension funds are Asian. In addition, pension funds in Asia are expected to double their assets over 2006-15, increasing to over $4.3trn by 2020. A key shift over this period will be the major change in market share by pension funds in the mature pension fund systems of Japan and Singapore and the significant growth in market share by pension funds in the developing pension fund systems in China, South Korea and India. However, in Asia, real estate currently does not constitute a significant level in most pension fund portfolios, largely reflecting regulatory structures and the conservative investment styles of many pension funds in Asia. Considerable reform is taking place in Asia as pension funds grapple with the issues of rapidly ageing populations, low coverage rates by pension schemes and a changing economic environment with increased urbanisation. The asset allocation focus on low-yield fixed income assets presents potential difficulties in meeting future obligations for an ageing population in Asia.

• Drivers for pension fund reform in Asia:
these include changing demographics (ageing population, declining fertility rates and early retirement ages), structural change in the economic environment (economic growth, increased urbanisation and reduced focus on agriculture), costs and inadequacies in the old defined benefit pension systems, the doubtful ability to meet future long-term liabilities with current low-yield asset allocations (significant fixed income asset exposure), impact of the global financial crisis on pension fund asset performance and growth in the funds management sector in Asia.

• Impact of demographic change on Asian pension fund investment strategies: changing demographics in Asia have significant implications for the ongoing financial viability of current pension schemes in Asia. Significant increases in old age dependency ratios are evident in all countries in Asia, particularly Japan, Hong Kong, Singapore, South Korea and Taiwan (where in all cases the ratio will be well over 50% by 2050). Significant increases in old age dependency will also occur in China and India. Most Asian countries are not adequately prepared for this rapidly ageing population over the next 20 years, resulting in unsustainable and financially constrained pension fund schemes in many cases. These worsening demographics are taking place in the space of just one generation, unlike in the West where similar trends have been spread over three to four generations.

• Detailed survey of Asian pension funds regarding their real estate investment activities and strategies: these challenges have driven pension fund reform in public and private pension fund schemes in several countries in Asia in recent years. Real estate is an important asset class for pension funds, with attractive investment characteristics that match the long-term liabilities of pension funds. These characteristics include secure, high quality income-producing commercial property assets, a high-yield asset class, less volatility than the stockmarket, attractive risk-return profile, portfolio diversification benefits, inflation-hedging ability and the variety of listed and unlisted real estate investment vehicles available. Globally, these features have resulted in real estate being included as a key asset class in pension fund portfolios in many countries for many years. However, with limited exceptions, this has not yet happened in Asia.

A key finding from the survey was a lack of knowledge of real estate compared to the other major asset classes, which hindered investment.

Importantly, a number of Asian pension funds have been proactive in reassessing their asset allocation and strategically increasing their real estate allocation, including South Korea's National Pension Scheme and Malaysia's Employee Provident Fund. Increasing their international real estate exposure is a key ingredient in the strategies of these funds.

Peter Mitchell is CEO of the Asia Pacific Real Estate Association