The West Midlands Pension Fund is staying committed to the real estate asset class following a strategic review. Richard Lowe talks to Brian Bailey about UK opportunities and expanding the global portfolio

The investment committee of the West Midlands Pension Fund sat down at the start of 2009 to discuss its real estate investment strategy. It confirmed its commitment to property as an asset class and decided to maintain a medium-term target allocation of 9% to real estate and 3% to infrastructure.

"We had a major review of our investment strategy in January with the trustees to take stock of what had been happening over the previous 12-18 months and where did we want to position the fund going forward," says Brian Bailey, director of pensions at the £6bn (€6.47bn at 31 March 2009) UK local authority pension scheme.

"It effectively reaffirmed that looking forward, despite all the turmoil, we still believed in a similar allocation to property."

The West Midlands Pension Fund has approximately £520m-worth of real estate holdings, predominantly directly held assets in the UK. This was boosted in March when the institution purchased a supermarket property in Birmingham for £36.5m. The store, let to Asda, covers 100,000 square feet and was bought from Land Securities through the pension fund's UK real estate manager and adviser ING Real Estate.

"We had some cash to expand the portfolio, so we were looking for good quality opportunities from people who were forced sellers," says Bailey. "We saw it as a quality property with a strong cash flow from a quality tenant. We will still be seeking further opportunities like that."

The pension fund invests in a number of sectors in the UK. Its biggest exposure is in offices, although it has substantial investments in industrial assets and retail warehousing, as well as shopping centres, retail units and a small exposure to agricultural land.

The pension fund sold some UK assets before the onset of the credit crunch. It sold a retail unit in Edinburgh in May 2007 and a Birmingham business park in September 2007. Both assets were seen to have poor prospects for rental growth and, given the impact of the credit crunch, the sales were considered by the fund to be "well-timed".

Today, West Midlands is much more on the buy side. "Obviously, we are not big sellers of property at the moment because we think it is a depressed market," Bailey says. "If there were opportunistic sales we might take them, but I can't see those coming along on any significant scale. So basically we are more in a buy mode than a sell mode to take advantage of the current market situation."

One of the areas where Bailey and the investment team have been most busy is in expanding the pension scheme's portfolio of indirect investments. To date, West Midlands has capital commitments to 17 real estate funds, the majority of which were made during the last 18 months.

"We've made commitments to a number of funds aimed at trying to get a broader balance in the portfolio," Bailey says. The funds, which include BlackRock's global property fund and AEW Europe's pan-European vehicle, target the value-added and opportunistic end of the risk spectrum. The overall strategy is to have a 70% exposure to developed markets and the balance in emerging markets.

The intention is to target higher returns relative to the domestic portfolio. "With a good anchor of a quality direct portfolio, what we are looking for is something with slightly higher returns but also accepting that there may be more risk," Bailey explains.

"For a number of funds we have a commitment but not much drawn down, because they are equally waiting for the opportunities to emerge. Hopefully, we have positioned ourselves where we can take advantage of some sales at good prices but also benefit from the uplift."

The West Midlands Pension Fund is somewhat unusual among UK schemes in that it is able to select real estate funds directly, without the aid of consultants. In the 1980s it developed an in-house team to select private equity funds, building up what Bailey calls "a robust due diligence process" that included the expertise to deal with all legal aspects associated with investing in limited partnerships. It was clear this process could be extended to cover value-added and opportunistic real estate funds, since they are predominately structured in similar sorts of vehicles.

Bailey explains: "We've got a fairly robust process that has worked well on private equity and there are lots of parallels between private equity and infrastructure and indirect property, in terms of the vehicles you are looking at, in assessing quality managers, their track records, who the investment partners are. So you can mirror across a lot of that."

The fund breaks its asset allocation into three discrete sections - equities, fixed interest and complementary assets. Real estate falls into the latter, along with emerging market debt, commodities, active currency and infrastructure. All of these are intended to generate strong returns while reducing equity risk. Real estate investments constitute the largest section of the complementary assets mix, representing 37% (as at March, 2008).

"The complementary assets are effectively trying to reduce the equity risk but generate equity-type returns or alpha. We sit property in that complementary asset group. Some people might call them alternatives, but we see an evolving strategy," Bailey says. "with a blend of complementary assets achieving our investment balance."

The expansion into overseas real estate funds - and infrastructure - was a product of the pension fund's 2007 investment strategy review. "We identified that infrastructure projects and indirect property were areas that would fit with our desire to reduce the equity risk - we had always been very big in equities - and hopefully get an equity-type return over the long term. So they were introduced then and we've been working through them," Bailey says. "The recent review in January confirmed the commitment to those areas that were made in 2007."

The total return figure for all asset classes for the West Midlands Pension Fund was negative for 2008 at -18%, but its five-year total return was 6%.

"We think that this is a few percentage points ahead of comparable funds, largely because of the diversification into complementary assets," Bailey says.


West Midlands Pension Fund at a glance

Total returns (31 December 2008)
2008: -18%; 3-year: 0%; 5-year: 6%
Real estate (31 December 2008)
2008: -19.7%; 3-year: -4.3%;
5-year: 3.7%
Real Estate allocation
AUM: £520m (€561m at 31 March 2009)
Target allocation: 9%