The real estate philosophy at AMF Pension is more about concentration than diversification. And with a price correction coming to Sweden, now could be a prime time for equity-rich local investors, Mats Hederos tells Richard Lowe

Until the summer of 2008, there was a general consensus in Sweden that the global credit crisis would prove to have a minimal effect on its own financing system and real estate market. Forecasts for the Swedish economy and for the country's property sector that year had been positive.

"It is another mood today compared with spring," says Mats Hederos, head of real estate investments at AMF Pension, Sweden's largest fund company with €25.6bn of assets under management, of which approximately €2bn is invested directly in domestic property.

Sweden became embroiled in the global financial crisis quite late, he says. "Until the summer, a lot of people in the property market thought there should be no reaction whatsoever in the market. After the summer, the effects have come to us and everybody is aware that we are in the middle of something that might turn out to be a crisis or a downturn, or whatever the label might be."

Hederos suggests that to stand by the argument that Sweden will remain strong while other economies fall around it is untenable. "We are part of the global economy," he says. "We might come out of this crisis better than other countries, but we will be part of it in one way or another. If it is better, we are happy. If it is as bad as in other countries, we don't know. There are a lot of questions but few answers right now."

And the Swedish real estate market is already seeing immediate effects, principally an almost complete drying up of bank financing for deals."That is absolutely what we are seeing right now," he says. "There are buyers and sellers, but there is no funding, there are no lenders. If it's zero or 10%, I don't know, but it is a very low activity from the banks and other financial bodies and therefore the transactions have almost stopped."

It is worth noting that Hederos made these comments just a few days before the Swedish government took steps to stabilise its financial system by guaranteeing up to €150bn of new banking borrowing and creating a fund to take direct stakes in banks if needed. There were concerns that downturns in the Baltic economies of Latvia, Estonia and Lithuania could undermine Sweden's banks, which control two-thirds of the total lending in these three nearby countries. The move was followed days later by the second half-point lending rate cut in two weeks.

The real estate market in Sweden might not be conducive to buying right now but, unfortunately, AMF Pension current strategy is to increase its property exposure. Furthermore, it is looking to do this by investing exclusively in its domestic market.
In 2006, IPE Real Estate reported that the institutional investor was planning to effectively double its real estate exposure from its allocation of 6%.

Latest figures (as at June 2008) suggest that it stands at 8%, but the long-term target is to be in the region of 10-15%. Clearly, there is plenty of capital waiting to be deployed. And waiting is the operative word. "We are in no hurry and we will increase when we have an appropriate market for that," Hederos says.

He adds: "We know what we want to buy, if it is in the market, and we know at what prices we want to buy," Hederos says. "In that sense we are on the sidelines, because we think there will be a lower price after six to 12 months." But he admits that it
is difficult in the present environment to make any hard predictions.Ironically, since the decision was made to increase its real estate allocation, AMF Pension has sold more properties than it has purchased. This investment behaviour has been driven by the high prices in Sweden between 2006 and 2008. This, of course, looks set to change.

"The reason has been the price," Hederos says. "We thought the price level had been too high and now we might see price levels where we can accept them and think it is reasonable long-term."It should be noted that the denominator effect - where falls in value of other asset classes inadvertently increase an investor's relative exposure to real estate - has been nominal. Hederos expects the effect to have been below 1%, if not less than 0.5%.

Once prices correct in Sweden and market activity picks up again, possibly in 2009-10, it is clear AMF Pension is destined to be a significant buyer. However, there are concerns about the nature of any correction. Certainly, the severity of the repricing in the UK caught the institution's attention. AMF Pension has tracked the historic patterns of Stockholm and London and is aware that there is a correlation of sorts.

"It is a bit scary," Hederos admits. "We have figures from the 1980s and Stockholm and London seem to follow each other quite well, even though we are maybe one or two years lagging in the process. If we see the downturn in the UK market, or London market primarily, it gives us some bad feelings."There is, though, the potential for the London market to be more acutely affected by the present crisis, because demand for real estate in London is more vulnerable to the health of the wider global financial sector compared with Stockholm.

"We do not depend as much as London on that industry, so it might differ a little bit this time," he says. "But still the pattern is clear from the history."If there is a severe correction in Stockholm, and Sweden generally, Hederos believes AMF Pension is "hedged" in a sense. If market values hold up fairly well, its existing assets will benefit, but if prices in Swedish real estate fall severely, then AMF Pension will be in a great position to buy a significant number of cheap properties as would be afforded by its large cash reserves.

AMF Pension's present real estate portfolio is made up predominantly of Swedish office assets, in addition to a slightly smaller collection of retail properties and an even more modest exposure to the residential sector.

One of Hederos's objectives is to increase investments in Swedish retail, specifically focusing on shopping centres in the city centre of Stockholm and other urban locales, rather than out-of-town malls. This focus is to benefit from the supply constraints of city centres because, as Hederos says, there has been "a tremendous construction period" in Swedish retail. By sticking to urban locations where "it is very difficult to find new space", he says it is possible for investments to be protected from the potential for oversupply in the retail sector.

While AMF Pension will be focusing on prime office and retail in city centres, Hederos admits he is not closed to the possibilities of looking at opportunities in other sectors.
"If it will be a very hard downturn, like we had in the crisis in 1992 in Sweden, there might be added opportunities in the market as well," he says. "We can't foresee them today, but we are open-minded to those kind of opportunities."

For example, it is not out of the question that Hederos could look at adding to AMF Pension's modest residential exposure. "So far, the prices in that sector have been too high, so we have not invested any more," he explains. "But that might turn out to be an opportunity in the future. We do not know. The future will tell us."But Hederos is keen to focus mostly on the retail sector in the near future. One of the reasons is that AMF Pension has been investing retail assets and familiarity with an asset class is seen as a positive virtue at the institution."We have been in the retail sector for quite a long time," he says. "If you have knowledge in the sector it is easier to have a good return. Since we are long-term investors, if we keep to what we are good at, we think that is the best way to do it."

Such language reveals some of the investment philosophy at AMF Pension. As Hederos says, it is very much "keep to what you know and understand and where you can have an influence". He explains: "That goes very close to our strategy when it comes to property. We intend to be in the market we know and understand and we can influence."

This is the main reason why AMF Pension has no plans to diversify out of Sweden with its real estate investments. In fact, Hederos sees very little need to diversify within real estate, because the asset class itself acts as a diversifier of the overall multi-asset portfolio. Instead, it is better to concentrate on the real estate markets you are most familiar with and where you can drive the best returns.

"We are a part of the diversification within the total portfolio," he explains. "We have no need for diversification within the property portfolio. We concentrate on the property portfolio to gain hopefully higher returns at lower risk, because we know the market and can have an influence on it."The role of the real estate portfolio is to offer a level of risk and return that exists somewhere between those of bonds and equities - the two other asset classes in which AMF Pension invests.

Furthermore, Swedish real estate is seen as beneficial to the overall portfolio, because its performance shows little synchronisation with either that of bonds or equities."For instance, last year equity and bonds was not that good, but property had a tremendous year," Hederos says. "That is good for our pension savers. We are somewhere in between bonds and equities, when it comes to volatility risk and returns. We have to be better than bonds long-term, otherwise we have no role to fill."

But with approximately €2bn of real estate assets under management, and a long-term intention to invest more, AMF Pension is a major player in what is a fairly limited property market in Sweden, in terms of size and liquidity. The country has also seen an influx of international real estate investors in recent years, although this is likely to have subsided in recent months. Hederos does not see any reason to be concerned.

"There are a lot of international players, but there is no fear from our side that we are not able to invest as much as we would like in Sweden," he says. "There are a lot of opportunities and properties, so that is not the case - even though there has been a
tremendous international inflow of money over the last five or six years."

He adds that these cross-border investors have largely been leveraged, whereas AMF Pension invests purely with equity. "The terms for somebody with leverage have been tremendous compared with, for us, not working with leverage whatsoever," he says.
One of the overriding themes of late is that equity-rich investors such as pension funds and insurance companies are in a much stronger position today - and look likely to continue to be for some time - than they were during the recent credit boom, when they were unable to compete with highly leveraged investors.

"If you compare returns on equity in a market where you have low interest rates, it is hard to compete with [highly leveraged players] as an equity investor," Hederos says. "But when there are no financing opportunities whatsoever it is better to be depending on equity as we are. Everybody has their time for good opportunities."