March 30, 2016
This short commentary piece has not been written tell you what I think you already know, but instead I am going to provide my own thoughts on what is going to influence global capital flows over the next 12 months and what I think is worth keeping an eye on for the future.
In any commentary today that involves the UK, we cannot ignore the elephant in the room and that’s Brexit. Brexit will or indeed is having major implications, and for the next 3 months I suspect will become a little tedious as each side makes claim upon counter claim and we witness the Tory party have a go at trying to tear itself apart.
Whether you’re an inner or an outer it’s going to have an effect. I am certainly hearing that most of the domestic institutions are now sitting on their hands, unsure about which way to go. They will, I think, continue to look for reasons not to do deals. During this period they are going to be looking hard at the Investment Managers Association’s summary of retail investor capital flows to see if the trend (witnessed at the end of last year) of a reduction in money to the sector continues. Their biggest fear will be redemptions forcing them to turn from buyers to sellers.
But whatever your view is on Brexit, pension money is still going to build up and it has to go somewhere, zero or negative interest rates are hardly that enticing, and I suspect that real estate with its solid income will ultimately still be a net beneficiary. Knight Frank’s recent long lease fund raising £300+m entirely through the Willis Towers Watson network tells you a lot about what they as consultants, and their pension fund clients are thinking at this time. The desire for income is as keen as ever, and I just don’t see that changing much whilst interest rates remain at current levels.
What Towers Watson’s stance also tells you is, I think, a reflection of how investors are increasingly thinking about their portfolios. Barbells are becoming the order of the day. On the one hand, will be an investment into a set of assets that will consistently give a solid income return of between 4% and 5%. At the other end of the barbell is alpha. Many many pension funds are underfunded so delivering income is fine to keep pace with regular liabilities but does nothing to address underfunding. Without a meaningful corporate capital injection, pretty unlikely today, the inclusion of some alpha generating strategies will be essential.
This barbell approach is not just a UK investment approach but can be seen elsewhere. I have just returned from a trip to the Middle East, predominantly Kuwait and Saudi Arabia. What I expected to find was a set of investors who, as many in the press have written, are busy repatriating money to prop up domestic situations in the light of falling oil prices. That may be true at sovereign level but it’s not what I saw at private level. The locals are worried, really worried. They are worried about a looming balance of payments deficit, they are worried about capital controls and they are worried about currency devaluation. Those worries result in a desire to keep money out of the country. Are they worried about Brexit – it was not mentioned once during our various meetings. Are they worried about Yemen, Iran and wealth preservation – you bet they are! The UK will, regardless of Brexit, remain a transparent and tax friendly destination for their capital. So I suspect you are going to see more of that capital here than you might have expected.
Having talked about the Middle East, let’s stay global and keep moving east and look at Asia. Again, the messages I am hearing from there is that Brexit is not the main question. The Koreans and Singaporeans continue to invest. The Chinese continue to fret about a Renminbi devaluation so investing offshore is going to continue, helped by new found freedoms and a recent harsh lesson in the benefits of portfolio diversification and let’s not forget there are more billionaires in Beijing now than there are in New York. Malaysia has oil issues and I suspect that their contribution to global capital flows will be much reduced.
Looking down under, it is also my understanding that the Future Fund of Australia is retreating closer to home. Having taken the view that it’s time to take profits from its early European investments coupled with the benefits of a fall in the value of their currency. Where Future Fund go, other Australian pension funds will follow, so despite Aussie Super’s recent acquisitions, I wouldn’t bet my shirt on a wave of money from that direction in the near term. The slow burner from the region is of course Japan. With the Government Pension Investment Fund of Japan intending to open an office here in London, we must expect the largest pension fund in the world soon to become an investor. As of today they have zero invested in real estate. And where they go, others will follow.
My own recent experience is however, Japanese HNW individuals who are here and buying, attracted by the benefits of our market and its current yields which even at the prime end are probably 200bps better than they see at home. So my tip is that you brush up on your Japanese etiquette as I think it will be useful in the years ahead.
If we keep going east, we arrive in North America and there seems to be no let-up in the monies being allocated by the US pension funds towards Europe at this time. I for one wouldn’t be betting against Blackstone Europe V with a target of €7bn being oversubscribed. I understand BREP Europe IV has invested two thirds of its €6.66bn capital and the returns already being delivered are well into mid-teens. But the question must be, with a target of 15% and 1.7x eqm, can it be delivered without taking some pretty major bets?
Yes that money will be raised but don’t expect those funds with a pan-European strategy to deploy in the UK today. With Brexit uncertainties the argument will run that they can afford to wait at this time.
The growth of the Goliath funds is well documented so I won’t repeat it here. But I would draw your attention to the new kids on the block who will become increasingly important in the market. The arrival of bond manager Pimco in the real estate space is yesterday’s news but keep your eyes on people like Stepstone recently arrived here from San Francisco. Their private markets group with $75bn of capital are busy raising money for secondary unit funds and will copy the likes of Townsend and Partners in their investment approach. These secondary funds are becoming important as they look to provide capital injections to managers and recapitalisation of opportunities. And Stepstone are not the only ones at it, Landmark Fund VII raised $1.66bn, Carlyle with its LGT group raised $400m, and Morgan Stanley Alternative Investment Partners Fund has raised $500m this year alone. Even Blackstone who acquired Credit Swiss RE Group is now raising a $1bn secondary fund.
And I couldn’t finish this short piece on global capital flows and US investors particularly without highlighting the Alternative Credit Industry that has grown up in the wake of a low interest rate environment. As the FT reported last year over the last 5 years these private debt funds lead by the likes of Lone Star, Oaktree and Apollo have raised over $318bn of new equity. Not all of that will find its way to the real estate sector but some will as they seek to exploit dislocated markets. Interestingly in the list of the top 30 private debt funds, by size only one comes from the UK – M&G.
So in conclusion – I think there is still a significant amount of capital globally that has yet to be deployed in the market. Some historic sources will be replaced by new ones. The UK, with its transparency, rule of law and tax friendly environment is likely to continue to see its fair share. A Barbell investment strategy will become more prevalent. But many investors have other needs and reasons to deploy capital here and they don’t see Brexit as the issue. Indeed, don’t be surprised if those from the Middle East particularly will use the current domestic buyer uncertainty to secure some assets over the next few months.
Author: Nick Cooper, Deputy Chairman for Palmer Capital