Chris Taylor, the boss of Hermes Real Estate, part of the Hermes boutique manager suite and owned by the BT Pension Scheme, says pension funds looking to diversify into real estate away from their home markets should be aware of implementation risks.
Pension funds with long histories of investing in real estate, namely Canadian and Australian funds, are becoming more adventurous in their allocations and looking to invest outside of their domestic markets.
Taylor (pictured) says that because the real estate market is imperfect there are always pockets of opportunities, but investors need to be cognisant of implementation risks.
BTPS has had an international portfolio of indirect assets since 2006, with broad geographical exposure, but opportunistically it is focusing on the US at the moment as well as on private real estate.
In managing implementation risk, Hermes takes the approach that an on-the-ground partner in offshore jurisdictions is a benefit.
In line with this philosophy the manager recently partnered with Hampshire in the US, and is seeking to replicate the partnership in France, Germany and Asia.
“A defining characteristic of Hermes Real Estate is managing implementation risk,” Taylor says. “We are not just responsible for the strategic overlay, but have control commensurate with the investment made.”
Implementation risk may include things such as style drift, Taylor says.
“A partner might say they are a core-plus investor when they’re not,” he says.
To manage this, Hermes RE draws on its strong history in corporate governance, cemented in its Hermes Equity Ownership Services and subsequently in Hermes Focus Asset Management, to act as a risk manager with its partners.
“We approve every deal,” Taylor says. “But not by introducing a layer of bureaucracy, we have a detailed pro forma, and investment parameters are well set out.”
Dynamic markets and structural changes to markets also present potential implementation risks, Taylor says.
“But we are careful not to put our manager in a straightjacket,” he says.
The manager doesn’t just buy the market, but believes in specialising in a sector and a region.
“For example we don’t just buy the US market, but go for idiosyncratic risk,” he says, adding that at the moment this is present in New Jersey.
Hermes could be a role model as a responsible investor in action when it comes to real estate. For one thing, it sets specific targets in its portfolios.
In Hermes Real Estate’s 2011 Responsible Property Investment report, Taylor says sustainable risks are integral to both functional and physical depreciation of buildings.
“Evidence has been growing which suggests that sustainable building characteristics will be associated with reduced risks of obsolescence and depreciation, enhanced tenant retention, reduced void periods, and reduced operating costs,” he says.
“Therefore assessing the associated risks has to be part of our standard investment process.”
Since 2006 it has measured the RPI performance which includes almost £1 million saved in cumulative energy costs and more than £1 million directly-averted landfill tax.
Its explicit new targets for 2011 include a number of climate change related targets, namely:
• A 40 per cent governance-led absolute carbon emissions reduction of its standing portfolio by 2020 compared to the 2006 baseline;
• 5 per cent management-led annual carbon emissions reduction adjusted for weather and level of occupancy on a like-for-like basis; and
• 5 per cent management-led annual carbon emissions intensity reduction by sector, adjusted for weather and level of occupancy, on a like-for-like basis.
While the motivation of such targets is largely noble – it’s aligned to BTPS’s requirements and there is investor demand outside of BT – there is also an economic rationale, Taylor says.
“The insurance premiums are the lowest in the industry.”
