In the first of two landmark reports produced for APREA, Professor Graeme Newell has explored real estate allocation trends among Asian pension funds. Peter Mitchell examines the findings

Unlike their North American and European counterparts, many Asian pension funds do not have either a fixed or focused real estate allocation, and those funds that do have one generally allocate small amounts.

A research report commissioned by the Asia Pacific Real Estate Association (APREA), authored by Professor Graeme Newell of University of Western Sydney, seeks to understand the significance of real estate for Asian pension funds and includes a survey of most of the major funds in the region.

Globally, pension fund assets increased from $17trn (€13trn) 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 property assets and its low risk and portfolio diversification benefits. And Asia has eight of the top 20 global pension funds. In addition, pension funds in Asia are expected to double their assets during 2006-15, increasing to over $4.3trn by 2020.

A key change expected over this period will be the market share held by pension funds in the mature pension fund systems of Japan and Singapore, as well as the significant growth in market share by pension funds in the developing systems of China, South Korea and India.

In Asia, real estate does not constitute a significant proportion of most pension portfolios, largely reflecting regulatory structures and the conservative investment styles of regional funds. The focus has been on domestic fixed income products.

However, considerable reform is taking place in Asia as pension funds grapple with rapidly ageing populations, low coverage rates 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 of reform 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); the impact of the global financial crisis on pension fund asset performance, and growth in the funds management sector.

The changing demographics in Asia, in particular, have significant implications for the financial viability of schemes. Significant increases in old-age dependency ratios are evident across Asia, particularly in Japan, Hong Kong, Singapore, South Korea and Taiwan (where ratios 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, in many cases resulting in unsustainable and financially constrained pension fund schemes.

Pension funds were surveyed regarding: current real estate allocations; criteria influencing real estate allocation; suitability of types of real estate investment; listed versus unlisted real estate allocation; selection of real estate fund managers; challenges facing real estate in pension fund allocations, and risk management strategies.
A number of reasons have emerged as to why Asian pension funds have not allocated more to real estate. These include:

• Lack of familiarity with real estate as a credible asset class;
• Liquidity issues;
• Lack of core and core plus assets in Asia;
• Concerns regarding alignment of managers' and investors' interests;
• In Asia at least, the need for more and improved market information and greater transparency;
• The need for more benchmarks.

However, by and large, the pension funds understand the need to increase allocations to alternatives - and to real estate in particular. The following is a brief summary of issues and views expressed:

• Pension funds understand there are benefits including portfolio diversification, access to global markets and risk management;
• Pension funds see investment as occurring via direct real estate and real estate investment trusts, both domestic and international. There is little interest in real estate debt products;
• Real estate is seen as a key element in any alternative asset strategy.

The overall view was positive but they have less knowledge of real estate compared with other assets. For many, it is a new asset class.

This lack of a full understanding with respect to real estate is an impediment to a substantial increase in investment in the sector.

Funds in South Korea and Malaysia and, to an extent, Thailand, have been the most active in implementing revised strategies, including an increased allocation to real estate (with the Koreans and Malaysians having made substantial investments in Europe and Australia in recent times), but they are still in the early stages of positioning.

A second report commissioned by APREA - also authored by professor Newell - covers the performance of both listed and non-listed real estate in the Asia-Pacific region and aims to create greater confidence on the part of Asian pension funds and other institutional investors to invest more in the sector.

Peter Mitchell is CEO at the Asia Pacific Real Estate Association