Copyright: David Lawson - Property Week July 2002
Hundreds of pages have been written about why investors should be piling into property. Equities are collapsing, gilts are static, so why is the flow into bricks and mortar still relatively weak? Most fund managers answer in three short words: ‘Blame the actuary.’ It is easily forgotten that investors spending billions every year on behalf of pension funds and insurance companies are not their own masters. Sitting quietly in the background are the real power brokers most property professionals have never met.
Actuaries have been dragged into the headlines by scandals like Equitable Life and fears that many endowment policies will fail to match mortgages. But they have long played a critical role in deciding how much goes into commercial property. In simple terms, each pension fund has a scheme actuary - usually an outside consultant - who values a fund’s liabilities such as future pensions then typically passes the task of matching future assets to a parallel group of investment consultants. They recommend how much should go into each asset class.
For decades funds have shied away from bricks and mortar in favour of equities and gilts for well-rehearsed reasons like poor liquidity and performance. The recent stock market crash has seen funds pushing more into property but this barely makes a dent in the long decline from up to 20% of assets in the early Eighties to less than 5% today.
There are signs that the swing may be more permanent, however. ‘Allocations have fallen too far,’ says Roger Boulton of Watson Wyatt, one of the giant firms providing actuarial and investment advice. Irrespective of returns, he is advocating that funds invest more in property to ensure better diversification. Others see property challenging bonds as a secure income flow.
The industry has been slow to encourage this kind of reassessment, says Gerry Blundell, European director at LaSalle Investment Management. Too few professionals have met an actuary, let alone tried to understand how they think. ‘They are a very intelligent group of people with a difficult job trying to square the circle of maximising returns and minimising risk. But they are not property experts. You have to learn their language and the restraints they work under.’
He has spent 10 years working with the Institute and Faculty of Actuaries helping bridge the gap since receiving a long questionnaire from an actuary when pitching for business. ‘I wondered who these people were and why they wanted such detailed information.’
The close examination sprang from actuaries’ other critical role, helping trustees choose fund managers. For a profession that relies so heavily on number-crunching, it is ironic that figures often take a back seat. Past performance is important but ‘people’ factors like quality and commitment of staff are crucial, says Jon Exley, a senior consultant with Mercer.
All the more reason why surveyors should spend time learning about this group of advisers who have moved out of the back room and into the centre of decision making. Since the law changed allowing multi-disciplinary partnerships, actuarial firms have broadened and moved further into investment advice. Nick Watts, European head of Watson Wyatt's investment practice, for instance, is a former fund manager, while Hewitt Bacon & Woodrow has just recruited a property fund manager.
It has a specialist team which advises on everything from sector weighting to management policies. But consultants will not go into fine detail, seeing themselves as strategic risk advisers rather than tactical decision makers. ‘We are not close enough to the market to make such calls,’ says HB&W. That is left to fund managers.
It is surprising that property gets such attention considering its well-known flaws. Some are self-inflicted, such as the way the industry blithely allowed the 1986 Financial Services Act to pass without demanding that bricks and mortar were treated as a special asset class. This produced a similar blind spot in the critical 1995 Pensions Act, which talks only of equities and bonds, lumping property into ‘other’ investments. Actuaries therefore treat the sector as alternative or ‘exotic’ investment along with areas like venture capital.
Another problem is that property has always fought for attention with one arm tied behind its back. At heart, actuaries are mathematicians working with complex models which aim to predict investment returns based partly on past performance. ‘But property does not fit well into this process because past data has not been considered reliable,’ says Exley.
Even current performance is difficult to digest because values change slowly compared with the boiling volatility of equities which can be checked almost by the second on computer screens. Big strides have been made through development of instruments like the IPD Index, yet even that has drawbacks. ‘It’s too smooth,’ says Blundell. ‘They don’t believe returns can be that good.’
Actuaries are not stupid, however. When markets change as radically as in the last few years, they take notice. But they generally value funds in three-year cycles, which is why many managers have champed at the bit over the last year, watching opportunities pass by.
Managers are not completely powerless, however, otherwise investment would not have increased. They have leeway to vary the balance of assets as long as they hit target returns, says Exley. Trustees can also flex their muscles. ‘We had calls from two clients last week asking for advice on property,’ says Boulton. ‘That could lead to new money going into the sector.’
Relative performance is not the only factor. Actuarial consultants are warming to property as inflation withers. For almost half a century most of the asset value lay in the prospect of rising rents. Now the benefit is seen mainly in the long-term secure income flow, so property should be considered more like a bond.
That slots almost perfectly into the needs of pension funds, particularly as they lose faith in equities and look for more secure income. But such advice is taking time to sink in. ‘I get the impression of partial movement but it is not substantial,’ says Exley. Trustees still remember the property crash, while some are reluctant to sell equities in a falling market.
The three-year cycle could be hiding an underlying trend, however. Mercer issued support for property in 1999, so the current revival could be the start of a big change working through the system. More recent influences such as the Myners Report and accounting changes requiring companies to report pension fund assets and liabilities, are also swinging firms like Watson Wyatt and HB&W in favour of diversification through ‘alternative’ assets like property.
Many funds would not find it difficult to justify pushing property up into the 5%-10% range, says Boulton. But, ironically, there may not be enough product to match this rising tide of interest. ‘It may be difficult to enter the sector given the lack of supply and high transaction costs,’ says HB&W.
New financial vehicles might be expected to help but they are no panacea. Limited partnerships reduce liquidity and may not be suitable for mature funds while returns from joint ventures may be harmed by having more people involved in decision making, says HB&W. Offshore funds ‘offer no real advantage’ to UK funds and are more expensive. Exley also warns that reforms like shorter leases could threaten the bond-like attraction of secure long-term income.
In the long run, better communication between the property industry and fund advisers could help ease these fears. Paul Herrington, managing director of the £4.6bn FISPAM/Royal & Sun Alliance funds says relations are far more comfortable than a decade ago because actuarial firms have separated the number crunching from investment advice and allowed fund managers the flexibility to do their job.
But there is still a gap to bridge. Blundell says half LaSalle’s new property mandates in the last 10 years have come from educating fund advisers about the sector’s strengths. Managers have also helped chip away at the wall by raising skill levels. ‘I am impressed by the huge improvement in sophistication over the last decade,’ says Exley. ‘They are far more like equity managers; far more aware of risk management.’
That is about the highest compliment to which any property professional can aspire.
Actuaries are people who find accountancy too exciting, according to the head of the profession. The joke cracked by Peter Clark, president of the Institute of Actuaries, to the Financial Times shortly after taking office this year plays on the image of cold, anonymous calculators working away on mathematical formulae in dusty backrooms.
The stereotype has been shattered by the market turmoil of the last few years. But it was already too simplistic. A handful of major firms which control the fate of property have evolved into global, multi-disciplinary partnerships which don’t just crunch numbers but provide a stream of investment and other advice to trustees. They include:
Watson Wyatt Worldwide advises 49 of the 100 largest corporate pension schemes in the UK. It was formed in 1995 through the alliance of the UK’s R Watson & Sons with The Wyatt Company of the US. Like most of the top players, it is a global consulting firm focused on human capital and financial management. Services range from employee benefits to finance, handled by 6,200 associates in 87 offices in 30 countries. Although separate legal entities, the UK and US firms share resources, processes and technologies, hold investments in one another and operate seamlessly around the world. Watson Wyatt LLP is a privately-held UK limited liability partnership but the US company, Watson Wyatt & Company Holdings, is listed in New York.
Hewitt Bacon & Woodrow
Bacon & Woodrow merged in June this year with Hewitt
Associates, a US-based global network with round 14,500 associates.
B&W evolved over 50 years from a small insurance firm, growing like other
consultants into pensions advice as private and directly-invested funds emerged.
The insurance practice was combined with Deloitte & Touche in May 2000.
The combined group is also the largest multi-service HR outsourcing provider
in the world and among the top 15 management consulting firms
Mercer Consulting Group vies as the world’s largest operator in this sector, with over 13,000 employees in more than 40 countries. It originated in the United States in 1937 as the employee benefits department of Marsh & McLennan, which is still the parent company, growing through a series of mergers with other consulting firms. This year it clarified the huge range of services by creating two separate entities, Mercer Human Resource Consulting and Mercer Investment Consulting. The aim is to ‘develop seamless human resource, benefit and investment solutions and deliver them to clients anywhere in the world.’Hymans Robertson
Hymans Robertson is an independent firm of consultants and actuaries founded in 1921 which remains wholly owned by the working partners. In May last year it joined Milliman Global, a new international client service organisation of independent actuarial firms, as its exclusive UK employee benefits consulting partner.Frank Russell
Frank Russell Company is a global investment services firm with more than US$1.8 trillion in assets. It provides investment programs to more than 1,000 clients in 35 countries, managing approximately US$70 billion in a variety of multi-manager funds, including mutual funds, retirement plans, commingled institutional funds, and private accounts. Founded in 1936, the firm became a subsidiary of the US group Northwestern Mutual in 1999.