SWIP: Widows’ funds inheritance is catalyst for measured growth

Property director Malcolm Naish is quietly confident about UK property’s prospects, and winning £2.3bn of mandates from Invista this year has positioned SWIP for growth. Jane Roberts reports

The 2011 summer break was characterised by bad economic news and renewed talk of a double-dip recession. As the atmosphere in London becomes increasingly febrile, there is something reassuring about being in the heart of institutional Edinburgh, at the office of softly-spoken Malcolm Naish, director of real estate for Scottish Widows Investment Partnership (SWIP).

Naish – four years into the job and with  a near 40-year investment management pedigree at firms such as Jones Lang LaSalle and DTZ – says he’s just been talking with an equities colleague about the effects of market volatility on real estate. “I told him we haven’t seen investors coming out of real estate or a fall in property prices,” Naish says. “He expected real estate would respond and pricing should be weaker. But we concluded that property pricing’s failure to move in the circumstances can be justified because of the income yield.

“Yes, you may not have rental growth expectations, and you might have concerns about all the income being retained in your portfolio. But gilt prices have risen and their yields have fallen; so although real estate’s equity or growth component has fallen, even a reduced property income return still has a significant gap over gilt yields.” However, Naish says a fall in capital values before the end of the year seems more, not less, likely, as evidence of investors’ caution emerges. For example, preferred bidder London & Stamford this month pulled out  of SWIP’s sale (on behalf of three Scottish Widows funds) of the 1.1m sq ft Redditch town centre, saying that the market is “hard to read at the moment”.

Naish says: “At the start of the year we forecast an average 8% annual total return over the next five years: 5% this year; 7% in 2012; and 9% afterwards. We suggested a bit of capital decline towards the end of this year; sideways ‘growth’ next year; then 2-3% rental growth and 1-2% capital growth, to give 9-10% returns.

Prospects for recovery

“Some secondary property is over-priced, consistent with views that it won’t attract an occupier or may not get rental growth for a while. Good secondary, prime and near prime – excluding hot spots – offers income preservation and will pick up first when the market recovery starts, say in three years.” Since 2009, SWIP has been busy buying retail parks, leisure schemes, distribution buildings, hotels and, this year, a lot of central London retail for its clients – especially the £2.3bn SWIP Property Trust and Scottish Widows With-Profits Fund.

In 2009 alone, Naish says, “We were the largest institutional net investor in the UK, buying £850m-£900m. It was a great point in the cycle for investing; there was a 44% average value fall and average values are still 30% down [ from the peak]. There’s still value out there, but one needs to be selective.” Since May, his team has also been active for new clients. That month, the insurance subsidiary of parent Lloyds switched the mandate for seven portfolios, with £2.3bn of assets, from Invista REIM to SWIP, swelling the latter’s property under management from £6.2bn to £8.5bn.

The funds are similar to SWIP’s existing client stable, mainly Lloyds group (HBOS and Clerical Medical) pension and life fund assets in UK balanced funds with core strategies, plus one European mandate (see table). Veronica Gallo-Alvarez is the only member of the 16 or so London-based Invista team who worked on the mandates to have joined SWIP. Naish says the main reason was that the jobs are now in Edinburgh.

“We have looked after the new assets with our existing team and by doubling up,” says Naish. “But we’ve recruited three or four property accounting people and seven in real estate will be announced shortly, including senior investment managers. We are also looking at promotions. By late next year, we expect to be a team of 50.” SWIP investment director Darryl Tidd has added the Clerical Medical With-Profits mandate to his responsibility for the Scottish Widows With-Profits Fund.

“He has experience of these kind of portfolios where the funds are in long-term decline and has been looking at how to manage that shrinkage,” says Naish. “We will be supporting him with new recruits.” Nick Ireland, who manages specialist fund the Airport Industrial Property Trust, has also been managing the HIFML UK Property Fund. The 18-month old vehicle is an open-ended investment company sold through Lloyds’ insurance channels and on transfer in May was holding £165m, or 55% of its assets, in cash.

Since then, Ireland has bought an £80m industrial portfolio and three London assets: 192-194 Oxford Street and Market Place from Great Portland Estates, at a 4.25% yield; forward-funded a Travelodge in Vauxhall; and bought retail and offices at 35 Marylebone High Street. “We have invested £150m since the mandate moved across,” Ireland says. The market view is that the mandates fell into SWIP’s lap when the five-year contract with quoted fund manager Invista came due for review at the end of August 2010, a year ahead of expiry.

While Lloyds Banking Group had a 55% stake in Invista, SWIP is the bank’s wholly- owned asset management subsidiary, managing £147bn of assets. The investment office of Lloyds’ insurance division took the decision about who should manage the £2.3bn of HBOS property. But rival fund managers thought the outcome was inevitable. Invista announced several potential takeover approaches earlier in 2010 and there was talk then of Lloyds wishing to reduce its stake.

Strong in-house team

It was also obvious that 100%-owned SWIP had a very competent in-house property team with experience of managing just these kinds of mandates. “I think Lloyds’ decision was quite logical from their point of view,” says one senior rival fund manager. “Although [taking the mandates from Invista] risked destroying value and was therefore something of a gamble, it was relatively small beer.” Naish declines to comment on the process except to say that of course there was a clear Chinese Wall between SWIP and the client (see below).

Lloyds’ commitment to SWIP seems assured after new chief executive Antonio Horta-Osorio pledged to expand wealth and asset management in his strategic review, announced on 30 June (see below). So SWIP’s real estate strategy will be to build up the newly enlarged property asset manage-ment arm and particularly to diversify SWIP’s strong retail and life fund investor base further into the institutional market.

One priority is expansion in Europe. Its first client there, the European Balanced Property Fund, started investing in 2004 on behalf of four investors. International real estate head Robert Matthews says: “There are two internal investors, one life company and a SWIP unit-linked fund, plus two external investors, from Germany.” SWIP’s second European mandate is pan- European fund PURetail, which buys retail-led, town and city-centre assets and is jointly  managed with Cushman & Wakefield Investors. It hopes to hold a second closing in the next six months (see below).

SWIP now has a third mandate: The Clerical Medical Non-Sterling Fund, which has about €140m of mixed assets, mainly in France, but also in Spain and Belgium. While the fund’s overall size is likely to fall, the client wants to raise its continental real estate weighting from around 3% to 10%, equating to around €150m of further investment. “Subject to the client’s agreement, we will look to supplement the direct portfolio with indirect investments, split between listed and unlisted, to double the fund by the end of 2012,” says Matthews.

His team would pick the unlisted assets themselves and be advised on the listed investments by SWIP’s real estate securities team, headed by Vicky Watson, who advises the SWIP Property Trust on its securities portfolio, which is worth around £160m. Matthews and Naish argue that the three mandates give the business real scale to build on in continental Europe. As well as Gallo-Alvarez, another imminent appointment will take the international team to six.

The others are Paul Findlay, who works on the European Balanced Fund, and Ross Braithwaite, who works on PURetail with Cushman’s Jens Göttler. SWIP research director Stewart Cowe, who is involved with  clients’ UK unlisted investments in funds such as X-Leisure, Apia Regional Office Fund and Retail Plus Property Trust, is also spending more time on Europe.

The next phase will be to open offices in continental Europe. This has been on the cards at SWIP since before Naish’s arrival in October 2007. One Scottish fund manager who knows SWIP well says: “They’ve talked about expanding into Europe for the past 10 years, so I remain a bit sceptical. But clearly there’s quite a bit of change going on and I watch with interest. Lloyds has given them the mandates; the challenge is to generate the energy to put a platform together.”

Slow push into Europe

Whether it’s down to today’s volatile markets, SWIP’s culture or his own nature, Naish says they won’t do anything before the new mandates are bedded down. “In the next three years we’ll put a presence on the ground in continental Europe. We’ll probably start that process this time next year.” Asked about other possible areas for expansion, Naish says a multi-manager business “is not on my radar, although SWIP has multi-manager businesses for other asset classes and real estate has the building blocks. By and large we are clear-cut about our indirect exposure – it is there to supplement what we do on the direct side.”

Diversifying into Asia was being discussed when Naish joined, but this was stymied by the market downturn. Expansion in Asia remains a “medium-term, five-year” plan, he says, and is most likely to follow the success-ful experience of the SWIP With-Profits Fund in the US, which invested via a joint venture. Naish adds: “A medium-to-long-term view of the demographics and urbanisation shows there is obviously a pull towards Asia Pacific. I absolutely believe the way to grow a business is to follow clients or lead them where you believe it is appropriate to go.”Meanwhile, he sums up: “The Invista mandates are a big win for us. It really motors us along and if we get it right – which we will – it will be the foundation  for all the other things we want to do.”


The switch that powered up SWIP’s mandates by £2.3bn

The process that led to £2.3bn of assets transferring from Invista REIM to SWIP began a year ago, in September 2010. Like other fund managers, Malcolm Naish says he had “been looking to see if there might be an opportunity to pitch” for either all seven, or some of the Clerical Medical and HBOS clients that had then been managed by Invista REIM for four years.

“We were invited to make a request for a proposal and to discuss our capability,” he says. In early October, Lloyds insurance group confirmed that notice was to be given to Invista and invited SWIP to make a detailed proposal. “We made a 70-80 page proposal, as did Invista, but I can’t tell you the extent to which anyone else made a detailed proposal,” says Naish.

“A clear Chinese Wall was put up between SWIP and the clients, because  of the clients being part of the group and Lloyds being a shareholder in Invista. We were quite rightly kept at arm’s length.” After the decision was taken to appoint SWIP, it was agreed that the mandates would transfer early, in May 2011, before  the five years was up, with Lloyds paying Invista a £3.1m early termination fee.

Lloyds keeps SWIP and Scottish Widows in the family

Life, pensions and investment company Scottish Widows has been a subsidiary of Lloyds Banking Group since 2000, when it  was bought by Lloyds TSB and demutalised. It is part of Lloyds’ insurance division. Asset management business Scottish Widows Investment Partnership is part  of Lloyds Banking Group’s wealth and international division and has £147bn of assets under management.

Its assets under management were boosted last year when Lloyds transferred £50bn of managed assets from HBOS subsidiary Insight Investments, acquired by Lloyds via the 2008 Halifax Bank of Scotland takeover. There was speculation in the first half of this year that Lloyds would sell either SWIP, Scottish Widows, or both. But on  30 June, the bank’s new chief executive, Antonio Horta-Osorio, said the bank would keep and expand both its insurance and wealth management businesses.

PURetail shops around for more institutional backers

As its first new product since 2004, the Pan-European Urban Retail Fund (PURetail) is an important launch for SWIP. Fund-raising began in 2009, a tough time for raising equity for unlisted property funds. But two new external clients came in at the €100m first closing this March: a continental corporate pension fund and a multi manager, investing alongside in-house fund Scottish Widows With-Profits Fund.

Last month the fund bought its first asset, a 4,800m2, mixed-use Düsseldorf building, for almost €20m. Robert Matthews, SWIP’s head of international real estate, says: “We anticipate having more assets under offer in Germany, France and Sweden shortly.” Peter Macpherson, who joined SWIP in January from ING in the new role of real estate commercial director, is working with Matthews on a second closing.

“We have interest from pension funds in southern Europe that want to diversify out of their home territories,” he says. Macpherson is also busy with another “seeded and sector-focused product”, which will be for the institutional market that he was brought in to target. Another potential product expansion  is an institutional vehicle for residential investment.