Tighter pension fund leverage could mean lower cash for property

bank of england

Institutional investors could reduce their allocation to commercial property amid a debt crisis facing many UK pension funds following the recent sharp rise in interest rates.

The problems with pension funds, created by their exposure to liability-driven investing, came to the fore after former Prime Minister Liz Truss’ mini-budget earlier this month.

Now these funds are looking to reduce their exposure to illiquid assets like real estate, Bloomberg reported.

PensionsEurope, a representative body for pension funds, said its members are reassessing their exposure to real estate and private equity because illiquid assets like real estate are not much use if the assets need to be sold quickly.

Earlier this month, the Bank of England intervened in the UK government bond market, buying bonds to prevent the price from falling too low. He said he was doing this because if he didn’t, pension funds risked going insolvent, threatening the financial stability of the UK.

Many funds had purchased bonds using derivatives as a complicated way of matching income from investment assets with the money they were expected to pay out to policyholders – a form of liability matching. When the price of these bonds fell, pension funds had to quickly inject cash to satisfy the margin calls on the derivatives they had used to buy the bonds.

This led to a fire sale of all liquid assets.

Many funds attempted to sell open-ended real estate fund units, but these funds closed redemptions so they could sell their underlying real estate assets over time.

The warnings of reduced allocations to real estate due to illiquidity come as the sector is already seeing a sharp decline in trading volumes as interest rates rise, making it harder for investors to going into debt to buy assets and making real estate less attractive compared to other financial sectors.

The reversal comes after a decade of ever-increasing allocations to real estate by institutional investors, driven by a search for yield in a world where interest rates were virtually zero, meaning that buying properties Bonds did not provide any income.