Long Lease Property - an attractive supplement to an LDI strategy?

Until very recently, only a limited number of UK pension funds would have considered real estate in conjunction with their liability driven investment (LDI) programmes as property was viewed as a ‘growth' asset. This position has changed, most notably over the last few years, as funding gaps have widened and interest rates have fallen to record lows. UK defined benefit pension schemes with liability matching requirements are challenged by this environment and will, at least in our opinion, continue their quest for alternatives to supplement their ‘low yielding' gilt exposure.

We believe long lease property is an attractive supplement to an LDI-based investment strategy and offers diversification to the underlying sovereign risk of a government bonds focused portfolio. The income derived from long lease property can have an element of inflation-indexation through Retail Price Index (RPI) or Consumer Price Index (CPI) related rent uplift mechanisms. This inflation-link is upwards only, meaning that the rental income would not fall in times of deflation. Lease terms of so-called ‘long lease properties' can stretch out to 20 years and beyond, and provide the maturity profile of cash-flows that is required by pension funds, which is rare for most types of investments.