Sara Sheen: Executive Director, Defined Contribution
Leonard Kaplan: Managing Director, Portfolio Manager and Head of Global Investment Risk
PGIM Real Estate
Adding Private Real Estate to DC Schemes: Time to Think Globally
In last month’s blog, NAREIT made the case for including underrepresented asset classes, such as real estate, in defined contribution (DC) schemes. This post further explores: 1) the specific benefits of private real estate allocations, 2) why a global allocation makes sense and 3) important trustee considerations for strategy evaluation.
Why Global Private Real Estate?
There are a number of factors that support an allocation to global private real estate, within DC schemes, which typically have much lower allocations than defined benefit (DB) pensions.
- ESG focus: Private assets often offer greater control and transparency around ESG governance considerations.
- Scale and liquidity: The size of the invested global private real estate investment market is approximately $11.2 trillion*, representing one of the largest asset class segments available to investors and offering ample selection for active managers to pursue adding investment value.
- Attractive long-term, risk-adjusted returns: Global private real estate has historically offered strong total returns over full market cycles, with solid downside protection characteristics supported by the segment’s strong income-generation potential.
- Diversification benefits: A private real estate allocation may help smooth out a portfolio’s overall returns by adding assets that have historically demonstrated lower correlations to traditional securities.
- Inflation protection: Private real estate has historically tended to perform well in inflationary environments because as inflation rises, generally so do property values and rents.
A Complement to UK Allocations
International private real estate investments can help complement domestic allocations by widening the opportunity set beyond what may exist locally and providing greater liquidity and diversification. While the UK offers a large institutional real estate market, other global markets can provide different characteristics and cyclical patterns, including greater upside potential and/or stronger downside protection attributes. Additionally, history shows that investing globally may help reduce exposure to idiosyncratic shocks.
Considerations for Trustees
Given our experience managing private real estate assets in DC for over 15 years, we understand how to successfully implement illiquid assets in DC schemes. Here are several important factors to consider:
- To maximize the benefits of illiquids, we believe private investments should be included within a professionally managed default fund rather than an option that is accessed directly by members.
- To ensure the default manager can efficiently manage cash flows and rebalancing activity, we suggest investing in a structure that combines large non-listed private funds with listed REITs.
- Large established institutional funds currently offered to DB schemes provide access to instant diversification, greater levels of liquidity and cost efficiencies as a result of scale.
- To align to other investments in the DC default fund, the strategy should offer daily pricing based on a consistent and repeatable process implemented by an independent third party.
In summary, we believe default funds should include global private real estate to improve diversification while benefiting from a focus on ESG considerations. We also believe strategies can be created to allow for daily dealing and liquidity in a cost-effective manner, leading to better outcomes for DC scheme members.
*Source: A Bird’s Eye View of Real Estate Markets, October 2021. PGIM Real Estate.