The show has already started
ING Insurance Benelux is already investing in line with Solvency II. Marieke van Kamp tells Richard Lowe why real estate managers should take notice
Solvency II is often portrayed as a fatal threat to the institutional real estate industry. The directive is said to penalise real estate unfairly and to fundamentally misunderstand it. What is less often heard is that Solvency II will enable investors to better reflect risk in their real estate portfolios relative to other assets. Yet, some people believe this, including the head of real estate investments at one of Europe’s largest insurance companies.
ING Insurance Benelux is already investing in line with Solvency II requirements – even though the directive is yet to come into force (or its details finalised) – and has developed an internal model that will allow it to set capital reserve levels that reflect its precise investment holdings.
Marieke van Kamp, who oversees the property exposure of the insurer, says the internal model will not only enable the institution to comply with Solvency II but also provides a new risk management tool. “It’s a better risk system than the former Solvency regulations,” she says. “It’s an additional instrument you can deploy in your portfolio management. That part is indeed welcomed.”
Of course, the effectiveness of the internal model depends on the quality of the underlying data. The less information available, the more assumptions have to be made and – broadly speaking – the higher the capital charge. For this reason, Van Kamp urges real estate managers not to view the greater transparency requirements that come with Solvency II as an unnecessary, punitive burden.
“It requires additional data from the fund manager and the investment manager on a quarterly basis,” Van Kamp says. “I have the feeling many managers see it as a burden – that it’s just a regulatory thing that you have to comply to. But I think it is important they see it as providing their investors with data that allows them to balance their risk and returns in the portfolio.
“If you do not have enough data, you have to take a prudent approach, which means additional capital charges. The higher the capital charges, the less attractive investments are. If you really go into the details and are able to have a model that includes all the risks of an investment properly, this adds to a better risk-return profile, which is ultimately also benefitting real estate fund managers and investment managers.”
Large insurers have the advantage of having the resources to develop internal models rather than relying on the standard model. The latter applies a 25% solvency capital requirement (SCR) to real estate – in other words, it requires the insurer to hold capital in reserve equal to 25% of the value of its property holdings. If ING Insurance Benelux used the standard model it would likely have to lower its real estate holdings. The internal model enables it to avoid such a course of action. Van Kamp stresses that the internal model “supports the property portfolio going forward” because it more accurately reflects the risks inherent in its real estate holdings by taking into account factors such as geography, sector and financing risk.
The standard model’s blanket treatment of property is based on historical data from the UK commercial real estate market, which is more volatile than – and so not reflective of – the wider European property markets. Research by Investment Property Databank (IPD) has shown that an SCR of 15% would be more representative of a typical pan-European exposure, taking into account the varying levels of volatility exhibited in different markets in the region.
“Were it not possible to make an internal model, it would be very hard to maintain the portfolio as it is,” Van Kamp says. “With the internal model, you are able to take a much more detailed approach to your property risk, country by country. That makes your portfolio much more manageable in terms of capital consumption and you can choose to lower your allocation to countries with high volatility and focus on countries with low volatility.”
The internal model has confirmed that real estate investments should employ only moderate levels of leverage, if any at all. “One of the main conclusions – which was already in our strategy – is that the less leverage the better, because leverage introduces unfavourable risks, thereby depriving real estate of its stable, low-volatile characteristics and deteriorating the risk-return trade-off,” Van Kamp says.
As the insurance company maintains its current allocation to real estate, it will naturally have capital to reinvest as certain real estate investments come to the end of their lifecycles. But Van Kamp is concerned – and in some cases bewildered – at the widespread use of leverage in strategies being marketed by real estate fund managers. “Funds in the market are still quite into leverage, which amazes me sometimes,” she says, citing examples where managers propose using up to 60% gearing, which they describe as “moderate”. “Are you mad? If you take the risk profile of such an investment in the real world, it’s twice what you expect from a normal real estate investment,” she says. “The additional risk profile is so clear in the figures.
“I have seen almost no fund without any leverage and I have seen some funds that keep their leverage below 30%, which I think is aggressive enough. I understand that you need some leverage to be able to act very quickly in the market, to not continually have to draw cash. But any additional leverage just adds volatility and costs to your investors.”
Asked why managers persist with relatively high levels of leverage, Van Kamp suggests it has simply become an ingrained feature of the real estate investment industry. “It shouldn’t be in my opinion.”
And it is not just insurers that are likely to demand low or zero leverage in their real estate investments. The IORP Directive for European pension funds, is following similar capital reserve requirements. “I sometimes wonder whether it has fully dawned on fund managers what the implications are,” she says.
As well as an aversion to leverage, the insurer’s internal model also reinforces the attraction of core real estate. “For an insurer, within the overall investment portfolio, real estate provides diversification to other assets, provides stable income and, in the long term, steady capital growth,” Van Kamp says. “You really have to focus on real core assets and that is what we are looking at.”
Of course, the huge demand for core real estate and the consequent yield compression has not escaped attention. “In a sense we are a bit on the sidelines at the moment,” Van Kamp says. But what about secondary locations and non-core assets? “That part of the market is better to be taken up by other types of investors.”