The largest pension funds are increasing their overseas exposure, finds Gail Moss

Portuguese pension funds are sophisticated enough to use real estate as an integral part of their portfolios. "Second pillar funds have around 5% of their AUM in real estate, compared with only 2% for insurance company funds," says Max de Groot, head of institutional clients at ING Real Estate Investment Management Europe.

Institutional market is inevitably limited, but he says that institutional investing is quite well developed. One big player is Sonae Sierra, a Portuguese property developer specialising in shopping centres, which has launched several real estate funds recently, with an international investor base including pension funds all over Europe. "These funds are also marketed to Portuguese institutional clients, and as the funds are non-listed, those clients become quite educated about such products," says de Groot.

This year, the developer has sold two supermarket sites to Santander and a logistics property to investment manager Aprirose. In another deal, property investment company Corio has paid €91m to developer Multi for the new Espaço Guimaraes shopping centre in northern Portugal.

According to Mercer, the overall average market exposure of Portuguese pension funds to real estate in June 2010 was 6.4%, down from 6.3% for 2009, (6.9% in 2008).

Rui Guerra, partner at Mercer, says that while the biggest Portuguese pension funds have both direct and indirect exposure to real estate, the smallest generally have only exposure via funds.

"Direct real estate exposure typically consists of plan sponsor-owned real estate that is included in the pension fund portfolio," he says. "Indirect real estate exposure, via domestic funds, has been seen by institutional investors as a low volatility contribution to the overall long-term pension fund investment strategy." And he says that the biggest pension funds are increasing their indirect exposure in Europe and further afield.

Luís Antunes, head of capital markets group - Lisbon at Cushman & Wakefield, says: "The key issue for pension fund investors is security - not just on returns, but on an exit strategy. In difficult times, they have too often found themselves as ‘hostages' of products they could not exit."

Antunes says the lure of indirect investment has diminished. "After a few years in which indirect investment was considered the best option, it has been hit by a set of products which are much more illiquid," he says. "And they are not providing returns much higher than direct investments."

The major part of property investment is invested domestically. According to the Imometrica/IPD Portugal Annual Property Index, capital values in Portugal fell by 5.7% in 2009. Worst hit was the retail sector, which fell 8.6%, while offices fell 3.1% and industrial buildings 2.1%. By contrast, income returns overall over the same period were 6.1%, giving a total return of exactly zero.

As a whole, Portugal underperformed the rest of Europe. The total average return for the continent over 2009 was 3.7%, according to the IPD Pan-European Property Index, with capital values falling by only 2% over the period.

But Antunes says the fall in domestic values has not been as sharp as it could have been. "Many of the funds were conservative in assuming an aggressive ‘mark to market' policy in the boom years, making the curve smoother."

For those pension funds which have not ventured abroad, it was largely a question of lack of size, as well as a lack of knowledge of other markets, Antunes says. "Meanwhile, those pension funds which have invested abroad have found themselves looking to an industry which is quite heterogeneous, and a large number of non-supervised funds. Although these funds advertise their governance and best practices, you do not have the comfort of a supervisory body which actively inspects whether what these funds say is carried out in practice." In Portugal, property investment funds are supervised the Securities Market Commission.

All is not gloom, says Antunes. "There is a stronger aversion to risk among investors who have become selective and look to quality. Some products have performed well, and seem resilient to the crisis. Also, compared with more core markets, some yields in Portugal are slightly more attractive to investors with market know-how."