Rome has a history of decline and regrowth, deterioration and reinvention. Against a backdrop of extensive urban decay and relentless political infighting, the Eternal City is once again showing its resilience, and its real estate market is showing some encouraging signs.
In the fourth quarter of 2014, transactions rose 14% on the previous year, representing the first positive numbers since 2008.
The Italian property market as a whole is showing improvement, with 6.2% growth in transactions in the second quarter of 2015, relative to the same period in 2014.
This is all good news for institutional investors such as Inarcassa, the €9 billion first-pillar pension fund for Italian architects and engineers, which boasts 170,000 members and currently has 40% of its real estate investments located in the Italian capital.
Established as a private company 20 years ago, the fund used to be invested in Italian sovereign bonds (60%) and domestic real estate (40%). Things have changed drastically in recent years, and Inarcassa is now one of the most sophisticated Italian institutional investors, with an 18.1% exposure to global property and a target allocation for alternatives of 17% in 2016.
‘Being the pension fund for architects and engineers gives us a hedge in terms of real estate investments, especially in Italy,’ Inarcassa’s CIO, Alfredo Granata, tells Modern Investor. ‘Our big focus now is alternative investments and different sources of diversification.’
Granata joined Inarcassa in 2011. At the time, there were still two investment departments, one for liquid assets and another focused on real estate investments. He now leads a unique division and runs a 12-strong team. This is soon to be expanded to include two or three people focused on private and absolute return investments.
‘Accountability and transparency are among our key targets. We are monitored by the economy, labour and justice ministries, as well as by a parliamentary commission. We also have an external risk-management company, which is crucial in defining our asset-allocation strategy.’
Inarcassa also works with Mangusta, a risk-management company that helps the pension fund structure, measure and check the risk profile of its portfolio. This is part of a process that sees Inarcassa appoint an external risk manager every three years to help build its strategic asset allocation.
Mangusta proposes three to four standard portfolios, which are examined and usually corrected by Inarcassa’s investment division, led by Granata. ‘We make them more realistic and suggest some parameters to respect, such as a specific allocation to real estate,’ he says.
After the adjustments are made every year, the investment division puts forward the portfolios to the board of directors and then to the delegates’ committee, which picks its favourite for a medium- to long-term strategic asset allocation. Every new investment idea from Granata and his team needs to stick to the general asset allocation framework and must be approved by the board of directors.
‘There might be tactical operations that result in a move away from the strategic asset allocation to adapt to different market conditions, such as a strong rise in volatility,’ he says.
The CIO and his team also implement some hedging strategies through the use of listed derivatives, so that the risk profile of the overall portfolio isn’t overly affected by short-term market swings. ‘The final phase is to monitor closely the performance of our strategies and the decisions made by our external managers,’ says Granata.
Less than 10% of Inarcassa’s portfolio is invested in-house. This proportion comprises Italian equities, Italian sovereigns and Italian corporate bonds. Everything else is outsourced through segregated mandates and investments in external funds. ‘We prefer segregated mandates, since they are a better vehicle for the amount of capital we wish to invest. Also, they provide more transparency and have lower fees.’
Generally, Inarcassa tenders passive mandates, since it seeks to implement strategies that adhere as much as possible to its underlying strategic asset allocation. ‘For equities and bonds, we make an active choice on where to go in terms of sectors, and then we pick passive products. Also, the risk overlay strategies, which are fully operated by us, are easier to implement with passive vehicles.’
In this area, the strategic asset allocation is likely to see increased exposure to alternative assets and a cut to its equity allocation. Currently, Inarcassa has a 30.8% exposure to fixed income and a 35% allocation to equities. ‘We want to take profit from our equity investments and limit the volatility risk, which will grow when the [US Federal Reserve] hikes interest rates. By Italian standards, we have a significantly large exposure to stocks at the moment.’
Granata is planning to trim his equity holdings in emerging markets and Asia Pacific in particular, while keeping his bond allocation in developing countries unchanged. Still in fixed income, he has a preference for European sovereigns (10.8%), and keeps positions in high yield (2.4%) and convertibles (3.1%) through external funds.
Liquid Alts and mini Bonds
Alternatives and real estate are separate allocations in Inarcassa’s portfolio. The first now accounts for 11.4% of the total investment, and will grow to 17% by 2016.
The pension fund started investing in alternatives in 2000. The holdings range from private equity to hedge funds and real assets to stimulate Italy’s economic recovery. Private equity, which was approached via funds-of-funds in the past, has started seeing direct investments into Italian and foreign private equity firms. In absolute return (8.6%), Granata favours liquid alternatives over hedge funds; he says they provide more transparency and liquidity.
‘We have been invested in hedge funds for the past 10 years. In our portfolio, they still have the function of diversifying our exposure and reducing market volatility,’ he says.
‘Following the global financial crisis, they have definitely lost appeal. Some of them started adopting strategies that were similar to long-only funds, therefore losing their uncorrelated nature but maintaining higher fees.’
Against this backdrop, Granata believes hedge funds will still be able to play a significant role in a more normalised market in the next five years. ‘The bull market is already ending, and we expect more volatility to come. Hedge funds could recover their original function as a diversifier and uncorrelated element in a bigger strategy.’
He also believes that fees could come down. ‘Market dynamics will reduce their costs, especially if performance is not great.’
The third section of his alternatives exposure is denominated real assets in Italy (1.2%). This is designed to stimulate the country’s economic growth. Inarcassa had been looking for infrastructure opportunities in healthcare and energy and invested in F2i, the company that set up the largest Italian closed-end infrastructure investment fund.
Elsewhere, the pension fund has allocated to a few mini bonds issued by small and medium-sized Italian enterprises. ‘We have also launched, along with two other Italian pension funds, a company called Arpinge, which aims to identify interesting opportunities in Italy within social infrastructure, such as care homes.
‘We would like to increase our commitment to infrastructure projects in Italy, but these are currently very difficult to find.’
Real Estate Foundations
Inarcassa has a special relationship with property investments. As outlined above, real estate initially represented 40% of the portfolio; now, it stands at 18.1%, 16% of which is in It aly. However, this may not be the case for long. ‘Things have changed in the past two years, when we decided that up to one-quarter of our real estate investments should be made outside of Italy in order to diversify our allocation.’
In December 2014, Inarcassa made its first overseas real estate investment via a mandate with LaSalle Investment Management in order to invest €85 million in global unlisted property funds in core and core-plus strategies. Then, in April 2015, the group awarded a second mandate, this time to US-based commercial real estate company CBRE.
In addition, Inarcassa has given almost all its Italian property assets to Fabrica SGR, an Italian company that runs 13 infrastructure funds, in order to enhance the efficiency of the real estate investment process in a challenging market environment. Currently, the pension fund has 25% in residential, as part of its historic legacy, 10% in hotels and care homes and the rest in offices. ‘In Italy, residential investments can be tricky. For example, it takes a long time to evict a tenant if he doesn’t pay his rent.’
Abroad, offices, retail and logistics are prevalent. ‘Forty-five per cent of our property holdings outside of Italy are in the US, 15% in Asia and 40% in Europe.’
With a degree in political economy, as well as a professional mandate to contribute to Italy’s economic recovery, Granata closely follows the developments of his homeland. ‘We are coming out of a very difficult period, but the last three quarters have shown some encouraging signs.’
He says he is not euphoric about Italy, but sees that things are slowly improving. ‘Foreign investors are keener to invest in the country. We have seen more initiatives in real estate and private debt. But we’re still talking about the kind of speculative investments that don’t show full confidence in the system.’ He believes that small steps have been taken, but says the nation’s structural problems are still far from being solved.
Elsewhere, he welcomes the transition of the Chinese economy from an investment-driven to a consumer-led model. His main concern lies in the delay of the interest rate rise by the Fed.
‘I don’t think that postponing the hike is the best solution. Between 30% and 35% of global sovereigns yield negatively at the moment. Even if this risk doesn’t seem real, history teaches us that the next bubble is just around the corner.
‘With such low yields in fixed income, even a small increase in market rates could very negatively affect returns in both government and corporate bonds.’