The risk curve for pension funds investing in Asia runs from slightly steep to vertiginous, as Shayla Walmsley reports

You could tell two contradictory stories about property investors in Asia and both would be true.

For some investors, the region represents indirect investment in mature markets with a currency hedge thrown in. For others, it represents development projects and a -Chinese residential market subject to tax raids by municipal bosses.

What the two groups have in common is a sense that Asian opportunities are unmissable. A survey of 110 investors conducted at the end of last year by Aviva found that most were looking to increase their exposure to Asian real estate markets over the next three years.

Driving the interest is a strong Asian macro story vis-à-vis moribund European economies. Even if the economic dislocation argument has been overstated, where there is an obvious impact - China's dependent on exports, for example - it will likely be mitigated by domestic growth. A fall in export demand as a result of the (not so) global economic crisis will be marginal in the short term and irrelevant in the medium term as exports continue to grow, according to Charlie Huang, Asia research analyst at Henderson Global Investors, who pointed out that domestic demand has been growing faster than nominal GDP.

Retail sales growth has averaged 18% in recent years. Huang calculates that with total retail sales at RMB12tn (€1.34trn) and exports at RMB7.9tn, given reasonable growth in retail sales, the decline in export demand will be safely matched.

As Vicky Sharpe, Asia CEO of Pramerica Real Estate Investors (PREI), says: "Investors are looking at the macro story but are investing in micro."

So what are they investing in? Given the uplift in office, it's perhaps surprising so many are avoiding it. According to data published by Cushman & Wakefield at the end of January, office rents across the Asia-Pacific region climbed by 8% in 2009-10, driven by well above average increases in Hong Kong (51%) and Beijing (48%). The researchers forecast prime Hong Kong rents will increase up to 25% over the next year.

Geert de Nekker, head of international real estate at Syntrus Achmea, who invests in Asia for several pension funds, says: "We have experience in the office sector and we've always had problems with it. It's volatile."

Yet investing in Chinese retail effectively means investing in development projects. ("With retail, there are value-added opportunities to take retail centres and turn them around," says Sharpe, "but no-one is doing it well consistently. Plenty of investors have tried, failed and exited the market.")

Despite a blip in Q2 and Q3 last year, transactions in China were worth US$197bn (€145.6bn) in 2010, up 23% on the previous year, according to data published earlier this year by Capital Analytics. Around 95% of these transactions involved development sites.

Even if macro growth is coming from China, and that economic growth is driving retail, many pension funds are still focusing on the region's mature markets. Choy-Soon Chua, managing director at SEB Asset Management, reckons you can pretty much cover the core, core plus and value add categories by investing primarily in China and Japan, with Singapore as "a rather small but nevertheless important market".

Yet pricing in mature markets - including Japan and Singapore - could well become prohibitive. Sharpe had Singapore as a target market for office for some of PREI's investment mandates "but that opportunity had already shut".

The obvious reason for the focus on mature markets is that, as Robert Stolfo, fund manager and director of business development at Invesco Real Estate, points out, the capital he invests is essentially conservative. As a result, "it's more a defensive strategy than an opportunistic one." In contrast, de Nekker claims some of the pension schemes he invests for are opting for an opportunistic approach but many are still focused on core. The opportunistic approach involves countries with population growth and urbanisation trends - not only China but Singapore, Thailand and Vietnam. Here the investment is in residential and retail, not office.

Although the DKK111bn (€14.9bn) -Sampension, which manages three Danish labour market pension schemes, now has investments in six Asian property funds, it has avoided China and India, instead focusing on Singapore, Malaysia, Japan, and "a little in Hong Kong", says head of property Henrik Kolind.

Capital conservatism also explains why even these investors continue to focus on indirect vehicles - and the fact that, according to data from Preqin, 71% of Asia-focused funds have outperformed the median return for global private equity real estate funds. Except for the very largest European pension funds, Asian property means Asian property funds.

Stolfo says his investors - insurance companies and large pension funds - are attracted to an Asian property fund he expects to close in the spring "because they are attracted to the idea that we can deploy capital via a German platform and a German-speaking vehicle but that we can deliver local access to the market without joint-venture partners".

He adds: "German investors are not shy in principle of joint ventures but they'll rely on a one-stop, in-house intercontinental vehicle. Otherwise, they'd have to manage joint ventures across different time zones, languages and cultures. I could understand if that gave them certain concerns."

Kolind says he is pleased with the way the scheme's Asian fund investments have performed over the past five years. Sampension returned to active property investing via the US market at the end of last year after freezing investment in real estate in 2008. Property makes up 10% of the fund's overall portfolio.

"Indirect investment has proved rather good. We're happy to be in funds," Kolind says.
De Nekker claims Dutch investors are similarly keen on the fund structure because it offers governance, transparency, clear investment procedures and the ability for investors to influence the fund's policy. "New funds will focus on these topics. All the procedures must be thorough and transparent," he says.

In other words, you have to know what you're doing. "There are many examples of investors being misled by the macro story and finding a very different investment market," says Sharpe. In China, PREI focuses on retail following train lines, investing in transportation nodes with residential attached. It's an opportunity created by neglect from local developers who focus on residential and don't want to build and operate assets.

For the fearless, there's always Chinese residential. Last autumn, the €266bn Dutch pension asset manager APG announced that it would increase its property investment in Asia by €1bn over three to five years, adding it to an existing €4bn portfolio and reportedly focusing primarily on residential.

Residential investors have largely welcomed measures introduced last year and in January to cool bubbling residential. But regulatory risk in China has more to it than central policy. At the end of January Shanghai announced (and the following day introduced) a 0.6% property tax to steer "speculators" away from the residential market. Some analysts quoted in the domestic press suggested Shanghai residential pricing could fall by 10% as a result.

Other state property taxes, such as a sliding tax introduced in Chongqing, have at least as much to do with municipal fund raising as they do with overheated property markets.
As revenue-raising opportunities go, apparently, that one was too good to miss.