Under its three yearly asset allocation review, VFMC decided to increase its allocation to infrastructure, property and private credit. Florence Chong speaks with Pete King about what this means for the property portfolio.
The year 2020 will be seared into the memory of many as one of upheaval. For managers of Australia’s superannuation savings, it has been a year of unprecedented challenge.
Aside from managing market volatility, many institutional investors have had to deal with the unexpected and, for some, sudden early release of member savings.
In a chaotic few months marking the second and third quarters of this year – and possibly ongoing for the next few quarters – the Victorian state investment agency, Victorian Funds Management Corporation (VFMC), has not just navigated through stormy markets, but its property team also has taken the opportunity to implement new strategies.
VFMC undertook its regular three-yearly review of strategic asset allocations for clients which started implementation last October, and decided to target increased weightings to infrastructure, property and private credit, but also to more cash to increase flexibility in client portfolios.
(Despite the pandemic) we are continuing to progress the evolution of our portfolio, broadening into new lines of investment.
“So we entered this year with higher liquidity,” says Pete King, VFMC’s Head of Property. “That has held us in good stead, positioning us to pick up opportunities arising this year.
“(Despite the pandemic) we are continuing to progress the evolution of our portfolio, broadening into new lines of investment.”
While increasing allocation to debt, VFMC has, for the first time, launched into A-REITs within its property portfolio, in addition to its A-REITs exposure in the equities portfolio, seeking to capture a disconnect between private and listed property markets.
With real estate debt now inching towards 10 per cent of VFMC’s $5 billion property portfolio, the fund is on-watch for new thematics as it transforms its portfolio.
Real Estate Debt
Real estate debt is a new investment theme. “We have seen, during the pandemic, that COVID-19 has accelerated the opportunity set in real estate debt,” says King, who has been with VFMC for 12 years.
“The pricing, and the number of opportunities, point to what we believe to be a growth sector in Australia, and, potentially offshore.”
Last year, VFMC gave a mandate to Madigan, the Sydney-based non-bank provider of real estate private debt, and, within a year, has more than doubled its allocation to real estate debt.
“We have done a dozen transactions so far, and five or six of those have taken place since March,” says King.
“The senior loans are spread across five different sectors. Lending to the industry gives us access to information across the property market.”
As part of the fund’s overall approach to active management, one of King’s team, portfolio manager Toby McMillan, works closely with Madigan to evaluate and approve each transaction.
King explains that the decision to go with Madigan, a joint venture between its senior management and Andrew Roberts’ RF Capital, was driven by Madigan’s skill in underwriting and its pipeline to funding opportunities.
Madigan was founded by Michael Wood, one of Australia’s most experienced real estate debt funders. Wood’s career stretches back to the 1990s, when he worked with Lendlease before becoming founding partner of US debt fund manager, Quadrant.
Often, there are opportunities in a particular sector where it is more attractive on a risk-adjusted basis to invest in debt rather than equity
“Madigan brings to the table skills in origination, underwriting and understanding of the appropriate terms and conditions in loan contracts,” says King.
“Their approach to underwriting, in terms of individual markets and sectors, is very detailed.
“Often, there are opportunities in a particular sector where it is more attractive on a risk-adjusted basis to invest in debt rather than equity. We have found Madigan to be good at seeking out such opportunities.”
Madigan is one of 10 managers VFMC works with to deploy its investment strategies. Currently, VFMC’s real estate portfolio accounts for just over 8 per cent of the $60 billion it has under management.
“We see real estate debt representing 20 per cent of our (property) portfolio in a couple of years,” King says.
He believes going overseas will provide diversification. VFMC’s property team is working on an overseas debt program, but this is yet to go before the fund’s investment committee.
In June this year, the property team put in place its own A-REIT strategy (separate to the fund’s equities allocation). “It has been designed to take advantage of the disconnect between the physical market and listed markets,” King explains.
“Clearly, the A-REIT sector is volatile. So far, we have done reasonably well. It is, however, a work in progress.”
While he is not prepared to disclose the allocation to A-REITs, King says the objective is to look at absolute returns, adding that this could be a relatively short-term strategy – perhaps running over the next one to two years while there is significant dislocation in the property market.
“We didn’t have the skill set and appetite within the organisation to do this during the GFC (global financial crisis),” he says.
The property investment consists of three people. Senior analyst Assi Toivakka is the third person along with King and Toby McMillan in the VFMC property unit. She complements the team with her analytical skills, says King.
In recent times, under its chief investment officer, Russell Clarke, VFMC has encouraged close collaboration between its investment teams to foster a whole-of-portfolio approach to investing.
“We are encouraged to collaborate to get better outcomes. Whenever an opportunity arises for collaboration, our CIO strongly encourages it. We collaborated in the past, but it was not possible to the same extent,” King says.
He says an example of this is the involvement of two colleagues from the fund’s credit team in developing a structure for the real estate debt strategy.
Normally, our peers in the industry funds can rebalance portfolios because they have such strong inflows. Usually, when we try to do something new, it has to come at the expense of another allocation
“They work with Toby McMillan (our portfolio manager) so that we get a better understanding of underwriting and terms and conditions. They literally co-manage our debt portfolio.”
With A-REITs, he says the equities team works with the real estate team to help flesh out the appropriate investment approach.
“We have another area of collaboration,” he says. “Our investment risk team has been particularly active in identifying common measures for risk across all asset classes.
“This has been especially helpful in how we manage risk across our portfolio and exploit the benefits of diversification in some of our new initiatives.”
One other sector being looked at closely, he says, is residential. It is, however, early days; an investment strategy has yet to be crystallised.
“We think build-to-rent and social housing are particularly interesting,” King says, adding, though, that it will not be until next year that the team has mapped out a concrete plan to enter the sector.
Unlike industry funds, which are fast-growing on the back of strong inflows, VFMC’s growth profile is more moderate, and has to be disciplined in how it manages and deploys capital, he says.
“The vast majority of our funds under management come from the state’s insurers and defined benefit superannuation funds, King told [i3] Insights. “We don’t have significant growth in inflows.
“Managing liquidity is harder when you have no significant growth.
“Normally, our peers in the industry funds can rebalance portfolios because they have such strong inflows. Usually, when we try to do something new, it has to come at the expense of another allocation.”
During the pandemic, industry funds have faced withdrawal demands from their members, together with switching pressure from those choosing to turn their savings into cash.
“Relatively speaking, VFMC has moved into a much more stable position in the last six months,” says King.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.