Market volatility has threatened to end Belgian pension funds' commitment to listed real estate. Investors are seeking non-listed exposure but the right investment solutions have yet to materialise. Richard Lowe reports

Most pension funds in Belgium have an exposure to real estate by investing in the listed markets. Large pension funds have in the past sold direct holdings and replaced them with internationally diversified real estate investment trust (REIT) portfolios, while for the smaller pension funds listed funds have always been the default choice due to their size and resources. However, the extreme volatility exhibited by listed real estate stocks over the past two years has made the pension fund industry in Belgium seriously question this approach.

For example, the pension fund of VRT, the public broadcasting company of Belgium's Flemish community, invests only in listed real estate. The experience of recent years has prompted the fund to view it as more akin to equity than real estate. "The market has taught us it is not de-correlated, but rather strongly correlated with our equities," says Florent Verberckmoes, senior investment officer at VRT Pensieonfonds. "The allocation has not changed but our view has, and what we've seen is that it is more equity-like."

The pension fund has not made any decision to change its real estate investment strategy, but it is planning shortly to undertake an asset liability management (ALM) study. "We will see what that study teaches," Verberckmoes adds. "But we are not planning to do any other changes before that."

Philip Neyt, chairman of the Belgian Association of Pension Institutions (BVPI), highlights the conundrum facing many Belgian pension funds; they are seeking the low volatility, inflation hedging and income producing aspects associated with real estate, but are often too small to invest in direct or non-listed (in Belgium the term ‘direct' is used to describe any real estate investments that are not traded on the stock markets, while ‘indirect' denotes listed real estate) and have to opt for a listed exposure by default.

Neyt says an ALM study will invariably show a pension fund that it should "have a quite large, important allocation to real estate, because real estate is in itself a good diversifier versus the other asset classes". He adds: "The problem is if you don't buy direct real estate, but you buy a listed real estate and it behaves like equity. That is the problem. You do an ALM study and you should have exposure to real estate. But if you look for the implementation it is very difficult."

Neyt says it is very problematic for the majority of Belgian pension funds to seek a direct or non-listed exposure, mainly because they are too small. "The problem always is how to structure direct real estate for smaller pension funds to have enough diversification," he says.

Karel Stroobants, an independent director on two Belgium pension funds, echoes many of Neyt's comments. He says recent ALM studies confirm that pension funds should increase their exposure to non-listed real estate and infrastructure. "There are quite a few big pension funds that I know of looking to move out of the indirect real estate due to correlations with the stock market. We have seen that indirect real estate quoted on the stock exchange was quite highly correlated with the stock market," he says. "There are a few bigger pension funds that have already made the decisions and are looking at how they can introduce or increase their direct real estate allocations."

The €1bn pension of Belgian banking and insurance group KBC has been reducing its listed real estate exposure since a change in investment strategy in 2007, diverting capital to non-listed real estate, infrastructure and other ‘real assets' such as timber. The restructuring has taken longer than anticipated given recent market falls in listed real estate securities, but Edwin Meysmans, managing director at Pensioenfonds KBC, is still committed to the task.

The pension fund has already invested in two European fund of funds managers, and is looking to build on this non-listed exposure either with successive fund of funds commitments or through investments in single funds. The problem for Meysmans is the lack of products on the market that meet KBC's requirements.

"We have looked at a number of funds, but we didn't like them for one reason or another," he says. One of the reasons is that many funds are too focused and do not offer the broad diversification required across the European markets. Many funds, for example, have a lot of exposure to the London and Paris office markets. "We would like to see more diversification. We're looking at a number of funds that may suit us, but we haven't decided yet," Meysmans says.

Stroobants says it is very difficult for smaller pension funds to look at non-listed real estate. "They are too small to make the diversification. It is easy to do that with quoted real estate. It is very difficult to do that with unquoted vehicles, because they don't have enough volume to make up a portfolio," he says.

However, Stroobants does know of a couple of projects being worked on to offer non-listed real estate and infrastructure investments to pension funds. One is the new offering from Dexia bank and private equity firm Gimv: a non-listed fund that will invest in cash-generating infrastructure and real estate projects in the Benelux region. The fund, DG Infra Yield, has already received capital commitments from a number of Belgian institutional investors, including Pensioendfonds voor de Bouwnijverheid - the pension fund for the Belgian construction sector - and is hoping to raise more before its first closing scheduled for September 2010.

The new vehicle follows an earlier fund, DG Infra+, launched in 2007, which was slightly higher up the risk scale, including Greenfield development activities.The new fund was a direct result of talking to Belgian institutional investors. "What we've noticed over the last 18 months is that this risk profile [DG Infra+] is probably still a little bit too high for local Belgian pension funds, which have very little exposure with this type of investment," says Manu Vandenbulcke, managing director of DG Infra+.

"You will probably see some initiatives where pension funds will have to work together and build a certain exposure," says Neyt. But the BVPI chairman also worries about future allocations to real estate given the scarcity of appropriate investment possibilities on the market. "I have big question marks about it," he says. "It can be done, but it is not only the case for real estate, but also for infrastructure and private equity."