Institutions have a wider range of domestic and overseas investment instruments available to them now than was the case 20 years ago. Examples include the growth in index-linked gilts, derivatives, trade in foreign exchange, and the expansion of global securities markets. These all absorb funds traditionally invested in real estate. This is supported by a recent questionnaire survey of pension funds by Booth, Matysiak & McCausland . Booth, Lizieri & Matysiak [1996, p. 151] summaries the results as follows:
‘… whilst many respondents felt that property had useful diversification characteristics, overseas equities and index-linked gilts had similar charac-teristics but without some of the perceived disadvantages of direct property investment. ’
‘… It was generally felt that any advantage of including property in a portfolio for diversification was negated by the inability to change property exposure quickly. Other assets, such as overseas equities and index-linked gilts are felt to be at least as useful as property in diversifying a portfolio but have considerable liquidity advantages over property. ’
Figures 2.1 and 2.2 below show how the asset mix of UK institutional portfolios and US corporate pension funds has changed. In the 1970s, UK pension funds had approximately 30% of their funds invested in real estate; the figure is now closer to 5%.
By reference to figure 2.3, UK pension fund investment overseas is seen to increase substantially during the 1980's. This was principally due to changes in the legal constraints affecting such investment, which included:
- the ending of exchange controls in October, 1979;7 and
- the relaxation (under the Insurance Company Act 1981 and its 1982 amendments) of the solvency margins required of both insurance companies and pension funds.8
These, combined with a greater understanding of exchange rate risk management and confidence in financial markets overseas, reduced real estate's relative attractions as a portfolio diversifier. By the mid-1980s, the investment performance of real estate
was being judged against equities, UK and overseas, as well as its own immediate past performance. Consequently, the equity boom exaggerated real estate's poor returns.
Even when real estate performance outpaced that of equities, in 1987 and 1988, UK institutions were either disinvesting from real estate or, more usually, reducing its relative weighting within their portfolios. As table 2.1 shows, this was often achieved without dealing as the relative value of equities rose, increasing their share of total portfolio values. Furthermore, after the international equity markets crash of 1987, funds were reluctant to invest in real estate as its proportion of total portfolio value held consequently rose, and continued to rise as performance outpaced that of equities until 1990; see figure 2.3.
7The end of exchange controls was not formally repealed until the Finance Act, 1987.
8These solvency margins were further reduced by the Insurance Company Act, 1994.