Property derivatives ‘could remain niche market’, delegates told

Peripheral property derivatives players need to actively engage in price discussions with counterparties or the sub-sector swap market will not survive, delegates at Monday’s IPD Property Derivatives Conference heard.

The second annual conference – which brought together bankers, brokers, real estate investors and end-investors at Thomson Reuters’ Canary Wharf headquarters – reflected on the value of derivatives strategies in portfolio hedging, rebalancing, asset allocating as well achieving international exposure, among other uses.

In Q&A session which followed the first public analysis of PRUPIM and the Royal Bank of Scotland’s £100m multi sub-sector swap executed last December, RBS head of property derivatives Phil Lujbic told delegates future trades of this kind require greater participation from potential traders and segment pricing disclosure.

Ljubic said: “A lot of the time it feels like a one-way street; we are showing our segment prices but, in terms of feedback, 95% of the time we get very little. The trade with Prudential was great, but it is just one publicly-known sub-sector swap trade, we have done others with hedge funds, but where are the property guys out there? We know some are interested but we need the feedback otherwise no
transactions will be done.”

PRUPIM and RBS multi sub-sector trade The rationale behind the December sub-sector swap between PRUPIM and RBS was to rebalance short-term segment exposure, according to PRUPIM’s Property
Derivatives Director Will Robson. Trading synthetically, he told delegates, saved time and money in the trading costs, which can be a drag on portfolio performance.

Robson added: “Segment derivatives trading can help to solve some of the problems faced by fund managers: these trades are not in conflict with existing asset allocation policy and, as such, they are purely property fund management decisions. We can find value between the relative pricing of segments all the way through the property cycle, rather than at specific peaks or troughs in the cycle.”

Robson likened the approach to the IPD attribution analysis methodology: substituting delivered performance with in-house forecasts for IPD segment total returns to derive relative portfolio performance and property scores to identify the performance drags.

He concluded: “This kind of strategy provides an extra layer of return in addition to the physical holdings; it is an extra layer of alpha – not an alternative to physical investment. It is a strategic switching of exposure of one segment with another, rather than the deployment of new capital into the market. As such, the level of return one would expect from the strategy is different.”

Following Robson’s presentation, Paul Rostas, Head of Property Derivatives at ICAP, the brokerage which advised PRUPIM, echoed fellow panellist Ljubic’s concerns. He said: “Transactions like the Pru’s reinforced the fact that sub-sector swaps are very powerful and are generating huge interest. But while we know of interested parties, but we need the [pricing] feedback otherwise no transactions will
be done.”

Legal & General and AXA Real Estate case studies Two additional derivatives cases studies were debated at the IPD Property Derivatives Conference; one from Legal & General Property and the second from AXA Real Estate. L&G director Michael Barrie told delegates his own house has
used derivatives in a variety of circumstances.

He said: “We have used derivatives for short-term liquidity, long-term hedging for certain funds and it has proved to be liquid, cost efficient, flexible and – above all – quick. Sub-sector trades, I think, will be a big win once we start trading properly in that space.

“The ability to not have to trade physical property but to adjust positions and maintain core holdings offers huge value. If you are running liquid open-ended property funds, not having property derivatives in your armoury is a bit of a risk,” he concluded.

AXA Real Estate’s Laurent Jacquemin explained the rationale behind the first-ever French Office sector swap, traded against the IPD French Office Index. AXA Real Estate was mandated to execute a €100m three-year hedging swap to reduce its clients significantly exposed to the French office market.

The December 2006 trade led to additional swaps on the same index. Jacquemin explained to delegates: “Our client used a derivatives strategy to maintain critical mass for its French office portfolio while benefiting from risk dispersion, achieving a significant spread over Euribor for its illiquid investment.

Jacquemin added that the trade also enabled the client to maintain portfolio alpha and “manage asset allocation more dynamically and optimize exposure more efficiently by creating an active and liquid derivative market”.

Property derivatives market could remain ‘niche’ In a lively address to delegates about the needs for further industry commitment to help the derivatives market blossom, Peter Sceats, director at Tradition Property echoed the sentiments of Ljubic and Rostas.

He told delegates: “Notwithstanding the enormous efforts of L&G and others in forcing through property derivatives-linked modernisation, the number of active end-users in the market remains small and while participation continues to be selective rather than serial.”

As a result, Sceats argued, property derivatives will remain a niche market whose volume comes in fits and starts. “Property derivatives won’t transition to major market status unless more end-users become more active. The market won’t build itself and if you believe you may want to use a property derivatives market in the future, it is not unreasonable to consider making more of a commitment now.”

source : IPD