UK - UK pension funds seeking inflation-hedging investments should look to their domestic real estate market in the current economic uncertainty, according to Legal & General Property (LGP).

Robin Martin, head of research at LGP, explained UK property acts as an effective long-term hedge against inflation and claimed it would even allow UK investors to hedge their bets "to some degree" should extreme scenarios arise such as a rapid bout of inflation or a deflationary spiral.

"UK leases tend to be long and generally have upward-only clauses protecting against reductions in rent, making commercial property a robust source of income during economic decline," said Martin.

If the latest UK Treasury consensus forecast is correct - GDP growth in 2012-13 at 2.6% pa and RPI inflation at 2.9% pa - demand for commercial real estate should improve and feed through into rents relatively quickly, enabling property to perform the role of an inflation hedge.

Greater levels of inflation or a bout of deflation would hamper real estate's hedging characteristics, but Martin believes it would be more effective than bonds or equities.

"Rent offers a different source of income than other asset classes, which means a well structured portfolio of commercial property has the capacity to perform better than equities in a deflationary world and better than bonds under an inflationary scenario."

A scenario that would "prove more problematic" would be stagflation, because property relies on growth in the economy to support rental and income growth.

But index-linked leases, as sometimes offered by the government and supermarkets, for example, would offer investors some sort of protection, he added.

Even if the UK economy follows the path of the Treasury forecast, the occupational market will be hit hard, so Martin stressed the importance of targeting prime quality assets with long leases which act more defensively during economic downturns.

Investors can also build portfolios which take advantage of property's "convertible" characteristics, suggested Martin, by going overweight on long-let properties to safe tenants and long on riskier assets in cyclical parts of the market that will benefit from an early upswing in the economy.

"Investors can build portfolios which are defensive in the short-term, but which naturally convert over time to a point where they can benefit from growth."

This strategy is being adopted by a number of LGP's real estate funds, including its fund for UK segregated pension schemes, which currently has cash to deploy in the market.

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