The purpose of this chapter is to provide overall review insurance companies and pension funds’ institutional frameworks, regulatory structures and investment allocations so as to have a grasp of their respective natures. Substantial part of the literature review shall focus on the overview of traditional and alternative investment asset classes with special focus on real estate and its characteristics influencing investment decisions. Drivers of real estate investment participation of insurance companies and pension funds are also examined. This is necessary to scope out the key data collection requirements for the primary research to be conducted and it formed part of the emergent research design process (Denscombe, 1998). It is an acceptable practice for researchers to familiarise themselves with existing research prior to collecting their own data (Easterby-Smith, Thorpe and Lowe, 2002).
2.2 Overview of Insurance industry
In its simplest term, insurance means the transfer of risk(s) from one party to the other for a fee called premium. In exchange for the payment, the insured (the one who has paid for insurance) is rest assured that should the unexpected happens to any item under the insurance policy, the insurer (the insurance company) would become responsible for resolving some or all of the problems. Its fundamental role of spreading risk is traceable to ancient past. Bottomry (a form of marine insurance) has been in existence for more than two thousand years. Property and Casualty insurance could be traced to Genoa in Italy in the early fourteenth century which was meant to support their active marine based trading activities (Lester and Wehrhahn, 2009).
As at today, the insurance sector a significant industry which covers a huge number of risks ranging from both natural and environmental hazards, life and disability risks through standard property risks (burglary, fire, explosion among). In the recent time, insurance sector has evolved in duties and become an important supplier of investment funds.
In 2003, seven insurance companies were among the top fifty corporations all over the world in terms of revenue and also accounted for two of the top four global financial institutions by the market capitalisation (Lester and Wehrhahn, 2009).
Nigeria witnessed a phenomenal upsurge in number of insurance companies between 1985 and 1990 during which more than 110 insurance firms were birthed. Consequent to the event, the National Insurance Corporation of Nigeria (NICON) which was created and later christened into NICON Plc by the Federal Government of Nigeria. Since this time, insurance industry has been recapitalised on two occasions with the first one introduced through Section 9 of the Insurance Act (2003). Specifically, the Act raised the minimum capital requirements by as much as 650%. After the exercise, more than 107 industry operators still survived (Akinlo, 2013).
Subsequently in 2005, the second recapitalisation exercise was conducted, this time around, the bar of capital base requirements was raised for life insurers to N2bn from N150m (more than 1,000%) and from N50m to N3bn for Non-Life operators. The exercise therefore brought Nigeria’s insurance industry to the current structure as it exists today.
According to PwC (2015), the Nigerian insurance sector is ranked 60th in the globally but the Nigerian government envisions that the industry is ranked amongst the top twenty markets in the world by the year 2020.
Table 1: List of insurance companies in Nigeria
- A&G Insurance Company LTD
- ADIC Insurance Company Limited
- African Alliance Insurance Company Limited
- AIICO insurance PLC
- Anchor Insurance Company Limited
- Capital Express Insurance Company Limited
- Consolidated Hallmark Insurance PLC
- Continental Reinsurance Company PLC
- Cornerstone Insurance PLC
- Crusader Insurance PLC
- Crystalife Assurance Company
- Custodian & Allied Insurance PLC
- Equity Assurance Company PLC
- Finsurance Company
- Goldlink Insurance PLC
- Great Nigeria Insurance PLC
- Guaranty Trust Assurance PLC
- Guardian Express Assurance LTD
- Guinea Insurance PLC
- Industrial & General Insurance Company Limited
- Insurance PHB Limited
- Intercontinental Wapic Insurance
- International Energy Insurance PLC
- Investment and Allied Insurance PLC
- LASACO Insurance Company PLC
- Law Union and Rock Insurance PLC
- Leadway Assurance Company LTD
- Linkage Assurance PLC
- Mutual Benefit Life Assurance PLC
- NEM Insurance PLC
- NICON Insurance PLC
- Niger Insurance PLC
- Nigerian Agriculture Insurance Corporation
- Oasis Insurance PLC
- Oceanic Insurance Company Limited
- Prestige Assurance PLC
- Regency Alliance Insurance PLC
- Royal Exchange Group
- Sovereign Trust Insurance PLC
- Standard Alliance Life Assurance Company LTD
- Standard Alliance Insurance PLC
- Staco Insurance PLC
- Sterling Assurance Nigeria LTD
- UBA Metropolitan Life Insurance Limited
- Unic Insurance PLC
- Union Assurance Company LTD
- Unitrust Insurance Company LTD
- UnityKapital Assurance PLC
Source: Nigerian Stock Exchange Commission, 2017
Insurance business is broadly classified into two (2) main categories viz: General insurance and long-term insurance. General insurance covers insurance of personal effects and properties against theft, burglary, travel and accidents, goods in transit, as well as legal liabilities. In fact, this category of insurance covers all forms of insurance except life. The common types of general insurance are motor, fire, home/property, marine, health, travel, accident and other miscellaneous forms of non-life insurance. The major characteristic of general insurance is that it is usually short term, annual contracts.
In contrast to general insurance, the long-term insurance which is otherwise known as life insurance is associated with risks relating to life expectancy and having longer period of maturity. According to the provision of Insurance Act 2003 in Nigeria, life insurance is divided into four (4) main classes namely: term assurance, life assurance, endowment assurance and annuity. Due to the nature of insurance businesses, these products and services are strictly futuristic and contractual. Hence, insurance institutions are denoted as contractual financial institutions (Ubom, 2014).
2.2.1 Institutional framework and arrangements of Insurance Companies in Nigeria
National Insurance Corporation of Nigeria (NAICOM) is responsible for supervising the activities of insurance companies in Nigeria and regulated by two main acts. The Insurance Act, No. 1 of 2003 (IA- which supersedes Insurance Decree No. 2 of 1997) oversees the licensing and the operation of insurers, reinsurers, brokers together with other providers of related services. According to the Act, all insurance companies must be established as limited liabilities companies in concordance with the Companies and Allied Matters Act, 1990, however, National Insurance Corporation of Nigeria (NICON) and Nigeria Reinsurance Corporation are exempted from this stipulation. The National Insurance Commission Decree, No. 1 of 1997 (NA) established NAICOM as the supervisory institution with power to inspect, enforce actions, and compose fines.There are eleven (11) individuals on the Governing Board of NAICOM representing professional entities and relevant public interest. Functions of NAICOM include licensing, approval of premium rates, setting of commission rates and designing policy terms and conditions, and protection of insurance policyholders and beneficiaries (NAICOM, 2017).
2.3 Institutional Framework and Arrangements Pension Funds in Nigeria
The legal framework of pension funds industry in Nigeria has undergone multiple transformations since the promulgation of the first Act in 1951 which was then known as the Pension Ordinance, retroactively effective from 01 January, 1946. In 2004, the industry witnessed the last major change with the passage of the Pensions Reform Act (PRA 2004), which introduced the Contributory Pension Scheme (CPS) and made it obligatory for both employers and employees in both the public and private sectors to contribute towards the retirement benefits. The current pension regime made provision for the establishment of National Pension Commission so as to maximise the potential of the Contributory Pension Scheme and thereby establishing guidelines for the activities of key players within the Pension Industry. The Pension Reform Act was reviewed and passed into law in July 2014 in order to further secure pension fund assets and drive industry growth (PwC, 2015).
2.3.1 The Regulation of Pension Fund in Nigeria
PENCOM was established in 2004 with over 4.3 million registered members (King and Wood, 2011). However this is a small proportion of the number of people who are employed in Nigeria. Prior to the introduction of the Regulation, PENCOM came to the conclusion that the way in which the pension system was operated in Nigeria did not provide the economy with the long term funding benefits that pension funds have the potential to bring. A number of the changes were driven by the importance placed by PENCOM on guaranteeing the safety of the funds and to ensure their survival. The Regulation has been introduced to bridge the gap between Nigeria’s infrastructure deficit and the combined supply of capital available from both public and private sector, by exploring the use of pension funds to obtain long term financing for infrastructure/real estate development.
In developed countries, pension fund (defined benefit, defined contribution and personal, whether employer-sponsored segregated schemes or insured schemes) are the most significant long-term investors in capital markets (Kim et.al, 2013). Meanwhile, the Nigerian pension sector features an organised ecosystem of participants (custodians, fund administrators and closed pension fund administrators) with distinct roles and all under the regulatory ambit of National Pension Commission (PENCOM). In 2011, the total Pension Fund Assets was N2.5trillion with average monthly pension inflows of N20billion (Henshaw, 2012). Meanwhile, according to the Vanguard Newspaper (2016), the total assets under Contributory Pension Scheme stand at N5.9trillion out of which N2.32trillion would be invested in infrastructure including real estate by 2019.
2.3.2 The Operators of Pension Funds in Nigeria
Pension funds operators in Nigeria are divided into three (3) main categories as follows:
- The pension funds custodians
- The Pension Funds Administrators
- The Closed-Pension Funds Administrators
They are discussed in detail below.
2.2.3 The Pension Fund Custodians
The Pension Fund Custodians, according to the institutional framework which is laid down by National Pension Commission (2006) in the Regulation on Annuity Under the Pension Reform Act 2004, are responsible for custody of the pension fund assets. The Pension Fund Administrators (PFAs) are not allowed to hold the pension funds’ assets under the Act. According to the laid down process, the employer is expected to send the contributions directly to the PFC, who then notifies the PFA of the receipt of such contributions and the PFA subsequently credits the retirement savings account of the employee. The Custodian is authorised to execute transactions and undertake activities relating to the administration of pension fund investments upon instructions by the PFA. The Commission further stipulates that, the Custodian thereby holds pension funds’ assets on trust (the PFA).
2.3.4 The Pension Fund Administrators
Pension schemes require pension funds to be privately managed by duly licensed Pension Fund Administrators which are fully authorised to create Retirement Savings Accounts for employees, invest and manage the pension funds in a manner as The Commission may from time to time prescribe, maintain books of account on all transactions relating to the pension funds managed by it, provide regular information to the employees or beneficiaries in accordance to the provisions of the Pension Reform Act (2004). Every Pension Funds Administrator is expected to be registered as a limited liability company before it is issued with an operating license.
2.3.5 The Closed Pension Fund Administrators
These Pension Fund Administrators are specifically dedicated to serve the staff members of particular companies and they fulfil the same roles performed by Pension Fund Administrators.
Source: Author’s pilot field survey (2017)
2.4 Insurance Companies and Pension Funds’ Assets
Insurance companies as contractual financial companies mobilise large amount of financial resources from policy holders through payment of premiums and invest part of the funds after disbursement of claims (Iyiegbuniwe, 1998). Irrespective of the sources of capital, long-term investors like insurance companies and pension funds need liquid assets to reflect short term period of existing liabilities in both life and non-life services. As the occupational pension system matures, an increase in annuities is expected, this will require long-term investment instruments. According to IMF report (2011), the investment portfolio of a typical insurance companies in Nigeria consist of 30% of short-term money market instruments, another 30% for stock/private debentures while real estate, loans and government paper make up to 40% altogether.
This investment is spread across wide spectrum of opportunities that exist in debt and equity markets, the primary and secondary markets, and recently in domestic and international markets. Given their nature and constraints, asset allocation of insurance companies and pension funds operators is dominated by “traditional assets” which is divided into three main categories namely: equities (stocks), fixed-income securities (bonds) and cash equivalents (money market instruments) (Roegge, Talbot and Zinman, 1971).
2.4.1 Traditional Investment
Traditional investment can be traced back to around 700 BC when the Lydians became the first western world to print and keep coins for future expenses (Bellis, 2017). As the need to meet expectations began to grow, individuals began to seek different channels through which money could multiply rather than keeping same. Time has evolved and investment horizon has changed too as investors are now interested in growth of capital, preserve the after-inflation value of capital, match or beat the ‘risk-free’ opportunity cost of capital and match or beat ‘risk-taking’ opportunity cost of capital (Yuthas, Bekefi and Epstein, 2008) and these objectives were intended to be achieved through investment in stocks and shares, bonds and money certificate, hence the origin of traditional investment.
Prior to global financial crisis, traditional investment vehicles were indispensible tools for risk and portfolio management to insurance companies and pension funds. But post crisis era, traditional income strategies have generated declining returns in the low-yield environment, insurance companies and pension funds operators have been stimulated to search for new investment opportunities, including alternative asset classes. For many companies, these investments constitute a fundamental transformation to their investment practices, to be harnessed not only to enhance returns, but also to better manage risk through portfolio diversification (Huyghebaert and Van-Hulle, 2004).
According to Eichholtz, MacGregor ,Hoesli, Nanthakumaran (1995), this diversification is happening in an evolutionary, not revolutionary, fashion. For all, fixed income remains the primary driver of yield. However, many insurance companies and pension funds operators who had previously focused efforts exclusively on selecting investment grade, domestic fixed income (i.e., core bond strategies) are now beginning to experiment with both higher-yielding investments and equity-type investments. In the face of current economic challenges, insurance companies and pension funds operators have found they need to fundamentally change their approaches to portfolio construction. Leaders are now deploying multi-asset portfolio optimization to harness the benefits of diversification to achieve superior risk-adjusted yields, without taking on outsized loss potential.
2.4.2 Overview of Alternative Investments
In its simplest definition, alternative investment assets are:
“those assets which are not part of the traditional assets such as cash, stock or bonds that retail investors are most familiar with” (WEF, 2015).
The above definition encompasses investing in mainstream assets like commodities, infrastructure, precious and industrial metals, luxury goods, arts, wines and of course, infrastructure. Literature (WEF, 2015, World Bank White Paper, 2013, Blackstone, 2017) have identified specific alternative investment assets which are peculiar with insurance companies and pension funds across the world and they include: private equity, hedge funds, infrastructure funds, and venture capital. For a better understanding, alternative investment could be summarised to comprise: commodities, real estate, collectibles, venture capital (private equity and other illiquid venture funding), direct investment in infrastructure projects and foreign cash held for investment purposes (Winchell, 2015).
Alternative investment is different from tradition investment due legal structures, leading to different fee structures, lengths of investment (lifespan usually range between 10 and 15 years), different levels of liquidity.
As the attempt to maximize returns in a low-yield environment increases, many insurance companies and pension funds operators have particularly tilted their investment allocations to a variety of alternative asset classes (Smietana, 2014; Steward, 2012; Opazo, Raddatz, and Schmukler, (2015); PwC, 2015) for the purposes of investment growth, portfolio diversification, positioning for maximisation of future opportunities.
Source: Author, 2017
2.5 Real Estate as an alternative investment
Investment in real estate can be considered as the employment of capital in the acquisition of land/landed properties or interests for undeviating ownership or for definite use of the person acquiring it (Smietana, 2014). Real estate investment in general is capital intensive; hence the need for a well scrutinised investment strategy in order to safeguard the sum invested.
Majority of institutional investors decide to included real estate their mixed asset portfolio for diversification benefits; return growth considerations and the fact that asset class is considerably a stable compared to some financial assets such as stocks (Greer and Kolbe, 2003). Björsell (2000) pointed out that insurance companies and pension funds investors resolve to invest in real estate because of its inflation-hedging characteristics even though this was not considered a major objective of investment.
2.5.1 Real Estate Characteristics influencing Investors’ Asset Allocation
- Portfolio Diversification possibility of real estate
General accounts portfolios of insurance companies and pension funds operators are largely driven by income oriented assets (CGFS, 2007). In order to back their short-term liabilities, investment in bond, stocks, commercial mortgage, and short-term holdings are well tailored to addressing the cash flow requirements.
There is a remarkable trend at which long-term-investors are shifting their investments towards capital-growth oriented assets especially if the evolution of investment portfolios is examined over the past five years. Jones (2012) opined that since 2008, there is a relatively stable allocation to bonds (approximately 72% of the overall portfolio) in the United Stated of America, there is a post-crisis growing redevelopment of cash and short-term bonds among insurance companies and pension funds operators leading to decreasing proportion of the overall portfolio to 4.1% in 2013 from 6.5% in 2008.
Insurance companies and pension funds operators have also gradually extended their international investment in real estate over the past years. Subsequent to the global financial crisis in 2009, there is an accelerated trend of investing in emerging markets with investors expecting investment performance to track the positive economic prospects of these countries (Kim et.al, 2003)
A close look at international diversification level of institutional investors, some pension funds- particularly large institutions in Europe and Canada – have a high allocation to foreign equities, with more than 80% of the total stock of total equities and 60% of fixed income on the one hand. Latin American pension funds, with the exception of the Chile and South Africa have very low levels of overseas investment, on the other hand. For instance, the South African Government Employees Pension Fund which is the largest pension fund in the whole of Africa had a negligible allocation to foreign equities (less than 2%) in 2011 and its fixed income portfolio was fully domestic (WEF, 2015).
Globally, the insurance companies and pension funds operators’ asset under management has grown to double in size of total Gross Domestic Product of Organisation for Economic Corporation and Development countries in 2012 (OECD Report, 2013). The report further stated that, after the global financial crisis of 2008, insurance companies and pension funds operators have grown peculiar tendency to expand their exposure to alternative investments like hedge funds, real estate, infrastructure, commodities, venture capital amongst others in order to meet various investment goals and optimise investment strategies.
- Income Generation
Another reason to add real estate to investment portfolios is its ability to deliver stable cash flows to the portfolio. Hudson-Wilson, Fabozzi and Gordon (2003) argued that, real estate is by far the most superior producer of steady income for investors globally. The authors further reiterated that if an investor desires to rely on earning a higher proportion of its total portfolio return from realised income versus unrealised capital appreciation, real estate is definitely a winner. The PREA quarterly report (Summer 2013) also covered detailed discussion on the income generating characteristics of real estate. Based on average annual total return between 1970 and 1990, Geltner (1993) pointed out that the bulk of the return to unlevered investments in fully operational properties comes from net rental income.
- Risk-adjusted Returns
According to Hunter (2012), an increasing number of insurance companies and pension funds operators tilting towards real estate investment while diverting from stocks, private equity and other forms of investment. In a laboratory work performed by Hudson-Wilson et.al (2003), it was discovered that on average, real estate did not outperform stocks and bonds in absolute terms for more than twenty-three (23) years but property assets outperform stocks and bonds when it was assessed in terms of total return per unit of risk. In the same manner, the research also found that returns from real estate surpasses that of both stocks and bonds on a risk-adjusted basis when Sharpe Ratio with assumed risk free of 5.4% is applied.
- Inflation Hedge
Real Estate returns are considered inflation hedge (Amidu and Aluko, 2006; Montezuma, 2004; Olaleye, et.al. 2003; Hartzell, Hekman and Miles, 1987; Fama and Schwert, 1977) as rents tend to be linked to inflation. As stated in the work of Hult, Lindskog, Hammarlid and Rehn (2012), neither shares nor bonds have such features. Prices of real estate are not quickly adjustable to the situation in the market. Unlike shares, lengths of contract alongside other specific factors affect property value and usually impose rigidity in the real estate market. It also follows that real estate prices are more likely predictable than other commodity prices in the market.
The recent incident of persistent increase in prices of goods and services has focused interest on providing answers to the question of which particular asset(s) provide effective hedges against inflation. Conner (2010) stated that, the ‘real’ nature and ‘income characteristics’ of real estate makes it a strong intuitive case for its ability to hedge against inflation. Property owners not only benefit from rising asset values but also from increasing rent. This assertion is in conformity with the claim of (IMF Report, 2011) that, during periods of inflation, certain financial instruments do not protect the investors but actually perform as a perverse hedge, the assets decrease in value as inflation increases.
- It Balances Liability Structure
For insurance companies and pension funds operators, liability structure plays a vital role in asset allocation decisions. These liabilities define the regulatory, contractual and financial responsibilities for managing investment obligations. So, pension funds operators like other liability-driven investors invest in real estate in order to balance their portfolios with strategies that are indirectly correlated with the performance of domestic equity markets and public debt.
- Potential for Capital Appreciation
At the most basic level, every real estate investor has the same goal. Whether portfolio diversification and risk reduction or cash flow and capital appreciation. The major objective is to make more money. Several studies (Guo, Zheng, Geltner and Liu, 2014; Ang, Nabar and Wald, 2013; Abraham and Schauman, 1991) have been conducted on real estate capital appreciation in the recent years. According to these authors, capital appreciation is described as an asset that is purchased at one fixed price point that rises in value over time. These values could be diluted or impacted on by taxes and inflation depending on the economic climate within the given country. According to the report published by JWB Real Estate Capital, the average rate of appreciation on a national basis in the United Stated is 0.2 percent (as at 2016) when adjusted for inflation while it was also stated in the same report that national average appreciation will remain between percent and 5.7 percent over the next five (5) years in the United Stated’ market.
2.6 Drivers of Participation in Real Estate Investment
A recent research stated categorically stated that the correlation among various asset classes including real estate is increasing (Blackstone, 2017). Despite this assertion, insurance companies and pension funds still commit funds into real estate investment. Literatures (Blackstone, 2017; Davis et.al., 2013) have pointed that there are other factors that drive investment in this asset class.
2.6.1 Availability of in-house real estate expert
In the world of financial complexities, the roles of risk managers centre on the understanding, monitoring and controlling risks in investment atmosphere. Risk management is defined by two major aspects: organisationally and functionally (Ho, Lai and Lee, 2013) citing Lamm-Tennant and Stark (1993). Through widespread research on real estate investment trends, the risks associated with investing and the long term returns have been studied extensively (Gold, 2005; Springer, et.al, 2005; PwC, 2012; Fabozzi, Shiller and Tunaru, 2009; Bartelink, Appel-Meulenbroek and van den Berg, 2015). It is therefore essential that insurance companies and pension funds operators possess a thorough knowledge of “how to manage” the potential risks associated with an investment in real estate when analysing the benefits of the potential investment. The specific risk factor variables can be tuned to suit the requirements and the particular real estate climate of the particular investment by the appropriate providing the methodology to identify and analyse the financial impact of loss to the organisation. In addition to that, in-house experts use realistic and cost effective opportunities to balance investment and the objectives of the organisation. According to PwC (2012), the future of real estate investment is tied to the opinions of experts who think globally especially in emerging markets.
2.6.2 Government Policy
Regulatory policies and investment ventures inescapable essentials and regularly effect on the business condition and monetary improvement of any nation (Simpson, 2008). Regulatory policies drive investment decisions through structure of taxes, the sum and nature of government support for landed property development, innovative work too large for single firms or with settlements too far or excessively questionable making it impossible to pull in private capital, the sum and nature of government interests in physical development and human capital, the lawful condition of operating a business, among different issues, the protection of intellectual property rights and the treatment of obligation claims.
Various administrative activities have been recently presented or are right now talked about in Nigeria, which seek to fortify dissolvability and risks administration practices of insurance companies and pension funds operators. A number of regulatory initiatives have been recently introduced or are currently discussed in Nigeria, which aim to strengthen solvency and risk management practices of insurance companies and pension funds operators. These regulatory policy initiatives share common features that influence the behaviour on insurance companies and pension funds operators in the country. These include: a directive by PENCOM about pension administrator’s mode of investment in real estate and the extent to which these firms could commit to it; the adoption of 30% ceiling for real estate investment by insurance companies; and a move to a greater transparency in Sovereign Wealth Funds accounts about investment commitments and funding positions.
In a report by Ernst and Young (2014) on the drivers of global real estate among investors in the United Stated, 88% of the respondents ranked property related taxation as the number one driver while 90% of the respondents chose availability of infrastructure as an important factor that influences real estate investment decision.
However in Nigeria, Guardian Newspaper (March 12, 2016), revealed that real estate industry stakeholders consider excessive and double taxation as banes to the involvement in property transactions in the country. The article stretched that both State and Federal terms of tax payment are confusing and contradictory therefore payers become involuntary evade tax which has severe consequences on businesses.
In a related article, (Olofinji, 2016) argued that investors lack confidence in Nigeria’s land related policies most especially the Land Use Decree (now Land Use Act of 1978). The report pointed out a bunch of issues in the real estate sector. For instance, Mallam El Rufai, the then Minister for Federal Capital Territory between 2003 and 2007 revoked all Certificate of Occupancy within Abuja in 2004. According to the author, investors believe that possessing the document which serves as the evidence of Government’s approval of ownership does not secure investors’ rights in a property. Land tenure framework is a mixed story because in the Southern Nigeria under customary law, land was organised largely around the community or family. It was almost impossible for individual to lay claims on any parcel of land as the owner and therefore could not alienate without the consent of the head. The tenure was however whittled down following the adoption of common law principles. In Northern Nigeria notwithstanding, the circumstance was clearly extraordinary as land was held and controlled for utilize and basic advantage of the general population who held a privilege of occupancy to the control and disposition of the native authority. Land Use Act tries to create a common ground between the existing tenure systems but rather, the Act has created more problems than it came to solve (Taiwo, 2012).
2.6.3 Investment Beliefs
Beliefs can be a powerful force and it is the essence of human living (DuCharme, 2015). In the investment arena, investors anchor strategies choices on beliefs that are far from guess work. These beliefs affect how they interact with other investors, classes of assets, future expectations and all aspects of investment including active-management philosophy when it comes to market and the need to achieve investment outcomes.
Koedijk, Slager and Bauer (2010) examined the direct relationship between beliefs held by pension funds and performance measures using an international sample of pension funds and it was discovered that the beliefs to which they adhere to affect the way they allocate resources and consequently the successes of their organisations. Similarly, in a report published by Deliotte (2014), it was stated that strong sense of purpose is the key driver of business investment. An organisation with a strong belief is more confident in their growth prospects; instil greater confidence in their stakeholders and more likely to invest in initiatives that can lead to long-term growth.
Long term investors are re-assessing their old beliefs (Gray, 2009) to stand the test of present times. The current economic situation provides an opportunity to test, refine modify and adopt investment beliefs and strategies derived from them. Real estate market is dynamic in nature, it constantly changes and this then calls for investors’ quick re-assessment of out-dated beliefs as it guides expected outcome from investments.
2.6.4 Economic Growth
There is a school of thought which affirms that investment growth is a consequence of economic growth. They are also of the opinion that an increase in economic growth leads to an increase in real estate investment (Kong, Glascock and Lu-Andrews, 2016). Shen and Liu (2004) have previously tested this assertion by analysing time series data on investment in real estate development across major cities in China. Their research found out that economic growth has an ‘undirectional’ impact on real estate investment. Similarly, Kuang (2011) conducted a verification research to ascertain the claims of Shen and Liu (2004) by finding interactional relationships between real estate investment and GDP of medium cities in China, the outcome of the research was in concurrence with the previous affirmation.
Economic grow8th restores investors’ confidence (Kuang, 2011). Confidence in an economy is a critical driver of economic fluctuations and business cycles. As investors gain more confidence, investment into consumer demands increases and vice versa. The relationship between investor confidence and investment was examined by Froot and O’Connell (2013) by developing an Investor Confidence Index model to measure risks appetite of institutional investors in North America. It was discovered that the indicator increased by +5.1 above the expected 100 points required for absolute confidence. The report noted that the rebound in the economy of North America is the main driver of this confidence. However, Batchelder (2016) reported a different scenario that institutional investors’ participation increases despite the dropping of confidence index in the region. This is a clear indication that current economic situation or the hope of a brighter economic performance motivates investors to commit funds to investment.
2.6.5 Rapid urbanisation
The United Nations in 2015 forecasted that the world’s urban communities to increase in population by 380 million individuals during the next five years. As a result of this, the entire world needs to build the equivalent of 5 cities the size of Los Angeles every year between now and 2020 (Snow and Kuhn, 2016). The development potential of this fast urbanization is tremendous, offering extensive open investment doors to both local and international investors that possess the ability to act fast. This portends a clear indication that the demand for real estate is increasing and will surge considering the entire new residential, commercial, leisure properties as well as infrastructure projects that such rapid expansion would require.
According to Knight Frank report (2016), cities in developed countries are forecasted to rise by 34 million by year 2020, this is the exact equivalent of 3 cities the size of Paris as of today. Meanwhile, cities in less-developed countries are expected to increase by 290 million individuals all over the same period which is about 12 cities the size of Shanghai. In order to keep up with the rate of urbanisation, insurance companies and pension funds are driven to initiate or increase capital allocations to real estate investment and this is expected to be sustained beyond short-term period (Deloitte, 2017). It is worthy of note that, an important characteristic of real estate investment market recently shows an increasing cross-border activities, especially in key countries in Europe and America.
2.6.6 Industry Performance and Market Trends
Due to the rapid urbanisation, the real estate market trend indicates an increasing participation of institutional investors across the world (Buckett, 2014). In the UK and Germany, insurance companies and pension funds have been reported for sourcing investment opportunities in the market (Buckett, 2014). Different property types will emerge according to the needs of each city, for instance Dubai EXPO 2020 will catalyse activities in its leisure market and large scale residential developments are projected to rise (Snow and Kuhn, 206).
Insurance companies and pension funds are dominating Swiss real estate market, accounting for 66% of domestic investment and 47% of total activity. They have gained market share due to the decline in activity from private investors. Similarly in Zurich, institutional investors accounted for 62% out of total 97% domestic investment in real estate in 2015 (Deloitte, 2017). Therefore, insurance companies and pension funds operators are driven to participate in real estate by market trends and expected growth.
2.6.7 Portfolio Diversification
Benefits of real estate as a portfolio diversification abound throughout literature in the past (Smietana, 2014; Hoesli and Lekander, 2007; Hoesli and MacGregor, 2000, Lazard, 2014). Some insurance companies and pension funds operators invest in real estate as a risk management strategy blending a wide an assortment of investments inside a portfolio. The rationale behind this technique contends that a portfolio constructed of various types of investment will, all things considered, yield higher returns and create a lower risk than some other individual investment found within the portfolio (Smietana, 2014).
Authors like Smietana (2014), Olaleye et.al (2007), Geltner and Miller (2007) and Jones (2012) conducted studies on diversification strategies and offer opinions on how to best construct investment portfolio which yields optimum returns.
2.7 The Role of Insurance Companies and Pension Funds Operators in Real Estate Development
According to Della and Yermo (2013), pension funds and insurance companies, are progressively vital players in global financial markets in fulfilling long-term physical investment needs across all sectors in the economy and specifically in employment, competitiveness and key drivers of growth such as the infrastructure and real estate and venture capital. In OECD nations alone, institutional investors held over $70trillion in resources as at December 2011, out of which 40% of the investment is represented by organizations situated in the United Stated. The OECD report further stated that, pension funds and insurance companies are most important investors in developed economies, having assets representing over 60% of GDP in countries such as the Netherlands, Canada, the United Kingdom and the United States while in non-OECD countries, insurance companies and pension funds operators tend to be less developed, with the exceptions of Brazil and South Africa, which have well-developed pension fund and insurance industries. South Africa actually has the largest pension fund industries both in absolute terms and in relation to its economy among non-OECD countries, holding assets representing over 60% of the GDP, which puts it at the level of the top OECD countries (OECD, 2013).
2.8 Insurance companies and pension funds operators’ Asset Allocation
The investment strategies of insurance companies and pension funds operators contrast altogether crosswise among different countries. Asset allocation is affected by a variety of factors, such as market trends, investment beliefs, regulation, risk appetite, liability considerations, social variables, governance structures, tax issues and ultimately eventually locally accessible resources (Della and Yermo, 2011).
According to CGFS (2007), institutional investors like insurance companies and pension funds operators have become the dominant saving medium for households in many developed countries of the world. The report further stated that the average household sector assets held by insurance companies and pension funds operators rose to 44% from 36% between 1995 and 2005. In a research conducted by OECD (2014), it was reported that the assets and asset allocation by 86 large pension funds and Public Pension Reserve Funds (PPRFs) among developed countries, which in total amounted to nearly USD 10 trillion in assets, are more than thirty three percent (33%) of the total worldwide assets held by this class of institutional investors.
2.8.1 Pension Funds’ Assets Allocation in Nigeria
The Pension Reform Act (2004) provides for the creation of a Contributory Pension Scheme (CPS) for any employment in the Federal Republic of Nigeria and stipulates the payment of retirement benefits to employees to whom the scheme applies; every public sector employee and for the Private Sector, employees in a firm with staff strength in excess of five (5) employees.
The major objectives of the scheme are to:
- Ensure seamless funding of the retirement scheme by assisting improvement of individuals save in order to cater to their livelihood during old age.
- Ensure that private and public sector employee receives his retirement benefits as and when due and to;
- Establish a uniform set of rules, regulations and standards for the administration and payments of retirement benefits.
The Pension Reform Act 2004 also established the National Pension Commission (PENCOM) with its main duties to include:
- Regulate, supervise and ensure the effective administration of pension matters in Nigeria;
- Approval, licensing and supervision of all pension fund administrators;
- Establishment of standards, rules and issuance of guidelines for the management and investment of pension fund under this Act.
In 2010, PENCOM released the regulation on the investment of pension fund assets (the “Regulation”). The prerequisites of the Regulation are consistent with the arrangements of the Pension Reform Act 2004. The Pension Reform Act and Regulation on Investment of Pension Fund Assets both regulate the investment of pension funds in infrastructure projects in Nigeria. They provide modalities, requirements and thresholds for such investments.
According to Section 86 of the Pension Reform Act, the modes of investment of pension funds are expressly provided, subject to the provisions of the guidelines prescribed by the National Pension Commission (PENCOM). The modes include but not limited to Federal Government bonds, bills and other securities, State and Local Government bonds, bills and other securities, banks deposits and bank securities and real estate developments. Whilst the PRA makes no express reference to any instrument for investment in infrastructure projects such as roads, telecommunications and or power, reference is made to “specialist investment funds and other financial instruments as the Commission may, from time to time approve” (insert reference here) In addition to the PRA 2004, the Regulation also provides more definitive guidelines for the investment of pension funds as it defines “Specialist Investment Funds” as infrastructure and Private equity registered by the Securities and Exchange Commission (SEC) (The Regulation 2012, Section 3.5(c)).
According to PRA 2004, pension fund assets could be invested only in allowable instruments which are bonds, treasury bills and other securities (including bonds denominated in foreign currencies) issued by the Federal Government of Nigeria and Central Bank of Nigeria or their agencies as well as purpose-vehicles and organisations created/owned by the Federal Government, given that the securities are fully guaranteed by the CBN and/or Federal Government. Under Section 4.7 of the PRA 2004, Real Estate Investment Trusts, Private Equity Funds and Infrastructure Funds (all registered by Securities and Exchange Commission) are classified as Investment Funds whose underlying assets are tangible physical assets. It is worthy of note that, due to reason of subjective valuation of real estate properties, Retiree Savings Account (RSA) Funds under management with Pension Funds Administrators (PFAs) must not directly invest in Real Estate; as investments could only be made through instruments such as Mortgage Backed Securities and Real Estate Investment Trusts (REITs). However, Closed Pension Fund Administrators (CPFAs) and Approved Existing Schemes (AES) that operate Defined Benefit Schemes (DBS) are allowed to invest directly in real estate, subject to Guidelines issued by the Commission from time to time (Pension Reform Act 2004, Section 5.2.6).
Retiree Savings Account (RSA) Active Fund
|Asset Class||Global Portfolio Limit||Per Issuer||Per Issue|
|1||Government Securities (including FGN Eurobonds)||FGN 80%||1.Maximum of 80% of total issue of FGN Bond.
ii. Maximum of 5% of pension funds assets in total issues of FGN Eurobond.
|i.80% of the FGN Bond issue
ii. Maximum of 2.5% of each issue of FGN Eurobond
|State and Local Governments:
i.20%, if issue is backed by ISPOs/Guarantees, as stipulated in Section 4.2
ii. 3%, if issue is not backed by ISPOs/Guarantees, as stipulated in Section 4.2
|Maximum of 5% of Pension Fund Assets in total issues of any one State or Local Government.||Based on the credit rating of the bond/debt instrument thus:
i.Rating of BBB: 16% of the issue
ii. Rating A: 18% of the issue
iii.Rating AA and above: 20% of the issue
|2||Corporate Bonds/Debts Securities (including ABS,MBS, GDNs, Eurobonds and Infrastructure Bonds)||35%, subject to a maximum of 15% in infrastructure bonds.||Maximum of 5% of pension funds assets in total issues of any one corporate entity.||A.Based on the credit rating of the bond/debt instrument thus:
i.Rating of BBB: 16% of the issue
ii. Rating A: 18% of the issue
iii.Rating AA and above: 20% of the issue
B.Maximum of 2.5% of each issue of GDN/Eurobond.
|3||Supra-national bonds||20%||Maximum of 5% of pension fund assets under management in total issues of any one multilateral development finance organisation||Based on the credit rating of the bond/debt instrument thus:
i.Rating of BBB: 16% of the issue
ii. Rating A: 18% of the issue
iii.Rating AA and above: 20% of the issue
|4.||Money Market Instruments (including Certificates of Deposits; Bankers Acceptances and Commercial Paper of Corporate Entities)||35%||A. Maximum investment of pension fund assets under management in all money market instruments issued by one bank shall be subject to its credit rating thus:
i. Rating of “BBB”: 3% of pension assets under management
ii. Rating of “A”: 4% of pension assets under management
iii. Rating of “AA” and above: 5% of pension assets under management
B. A maximum of 3% of pension assets under management may be invested in all money market instruments of any one discount house with a minimum rating of ‘A’.
C. For a Commercial Paper, maximum of 5% of pension assets under management may be invested in total issues of any one corporate entity with a minimum rating of ‘A’.
|Applicable to Commercial Paper issues only.
Based on the credit rating of the bond/debt instrument thus:
i. Rating of ‘A’: 18% of the issue
ii. Rating of ‘AA’ and above: 20% of the issue
|5||Ordinary Shares (Including GDRs)||25%||Maximum of 5% of pension assets under management in any one corporate.||i. Maximum of 4.5% of the issued capital of any one corporate entity.
ii. Maximum of 2.5% of the value of GDR issued.
|6||Infrastructure Funds||5%||Maximum of 5% of pension assets under management to one issuer.||Maximum of 20% of any one Fund.|
|7||Private Equity Funds||5%||Maximum of 5% of pension assets under management to one issuer.||Maximum of 20% of any one Fund.|
|8||Open, Close-End and Hybrid (including REITs and ETFs)||20%||Maximum of 5% of pension assets under management to one issuer.||Maximum of 10% of any one Fund.|
Source: National Pension Commission, 2012
2.8.2 Insurance Companies’ Asset Allocation in Nigeria
NAICOM Operational Guidelines 1.10 requires insurers and reinsurers to have investment policies appropriately approved by the board. All investment decisions shall be guided by the board-approved investment policy, and the basis for investment selection shall be properly documented for independent review. Such policies should recognize the nature and differences between funds available to the insurers/ reinsurers and all investments relating to insurance funds need to be distinguished from those representing other funds in the financial statements. Recognized assets for solvency purposes are defined as admissible assets and subject as far as possible.
- Not more than 20 percent of the total current accounts balances and bank placements shall be placed in any one bank.
- Not more than 20 percent of the total equity investment shall be placed in the security of one company.
- No insurer/ reinsurer shall invest more than 25 percent of the proceeds of public offers and private placements of shares in non-insurance related companies or ventures.
- Subject to the liquidity required for relevant obligations of the insurers/reinsurers, the following limits should be observed with regards to investment-type decisions on insurance funds.
- Quoted equity, not more 50 percent
- Unquoted equity, not more than 10 percent
- Property, not more than 35 percent in the case of life insurance funds, and 25 percent in the case of non-life insurance funds.
However, in developed countries like Switzerland, real estate investment must be located within the country and are limited to 25% of technical provisions. Turkey requires real estate investment by insurance companies to be located in an OECD member country while in Estonia, Poland, Portugal and Turkey, investment to one immovable property or construction work which proximity enables them to be considered as one property is limited to 10%.
2.9 Asset Allocation Strategies
2.9.1 Strategic Asset Allocation
Diversification Strategic asset allocationor sometimes simply referred to asstrategic asset allocationrepresents the act of establishing a portfolio with a blend of investments intended to fit the asset parameters of the investor.. In another words, strategic asset allocation calls for setting target assignments and after that intermittently rebalancing the portfolio back to those objectives as investment returns skew the initial resource allotment rates. A key assumption is that those parameters will remain relatively stable over the long term. This implies that, if the investor’s long-term goals and risk resistance are best served by 60% value and 40% fixed income portfolio (this will have been resolved through a thorough venture and budgetary arranging audit) at that point which will be set as their objective portfolio until their investment objectives and risk resilience change altogether. Since resource costs change, investors and investment administrators would set criteria for rebalancing to the pre-set focuses for the harmony between equities, fixed income and additionally for the individual asset classes inside each of those bigger classifications.
Strategic asset allocation could also be referred to as “buy and hold” strategy, instead of tactical asset distribution which is more suited to an active trading approach. This is erroneous since extraordinary care is practiced to ensure that the asset-to-asset extents stay stable regardless of market variance which requires occasional rebalancing. Buy and-hold regularly proposes that after the underlying investments, no progressions are made for rebalancing regardless of market value vacillations.
2.9.2 Tactical Asset Allocation
Tactical asset allocation is an active management portfolio strategy that shifts the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors. This strategy permits investors and portfolio managers to create extra value by taking advantage of certain situations in the marketplace. It is as a moderately active strategy since investors return to the portfolio’s original strategic asset mix when desired short-term profits are achieved.
During the process of creating an investor policy statement (IPS), factors such as required rate of return, acceptable risk levels, legal and liquidity requirements, taxes, time horizon and unique circumstances are analysed to settle on a strategic mix of assets to include in an investor’s portfolio. The percentage that each asset class is weighted over the long term is known as the strategic asset allocation. This is the mix of assets and weights that will help an investor reach their specific goals (Vanguard Investment, 2017).
2.10 Trends in Insurance Companies and Pension Funds Operators’ Asset Allocation
According to OECD report (2013), insurance companies and pension funds operators’ exposure to alternative assets has continued to grow, extending a long-established trend and reflecting the growing appetite among pension funds for diversification, their search for yield, capital appreciation and long-term steady income from investment. These institutional investors have been increasing allocation to alternative assets such as hedge funds, real estate, private equity and, most recently, infrastructure, including ‘green infrastructure’.
Literature (WEF, 2015; Çelik, 2013; IMF, 2011) reveal that insurance companies and pension funds operators are gradually increasing their exposure into overseas markets in the recent times. Sequel to the last financial crisis, there is an accelerated trend of investing in emerging markets, with investors expecting investment performance to track the positive economic prospects of these countries.
A perusal at the level of international diversification of individual investors reveals that some pension funds – particularly in Europe and Canada- have a high allocation of funds to foreign markets, with exposures representing more than 80% of the total stock and 60% of fixed income. However, Latin American pension funds, with the exception of the Chile and South Africa have very low levels of overseas investment. For instance, the South African Government Employees Pension Funds which is by far the largest pension fund in the African continent, had a negligible allocation to foreign assets (less than 2%) in 2011 and its fixed income portfolio was fully domestic.
Maller (2006) observed that insurance companies and pension funds operators in the United Kingdom chose private equity markets, and the trend continued with even greater regularity as they included alternative investments like real estate, hedge funds, leveraged buyouts, funds of funds to diversify investment portfolios.
According to Campbell (2015), the insurance companies and pension funds operators in the United Stated had sentiment for acquiring large blocks of multifamily apartments due to recent market reported which categorically stated that investment in multifamily apartments are strong and demographic trends would remain highly favourable for the apartment sector with a substantial lift coming from millennials entering workplace and forming households.
Recently, there has been growing changes in the activities of asset management of insurance companies and pension funds operators which involve a series of delegated processes, linking the ‘triangle’ formed by invested funds, fund owners and fund managers (Gyntelberg, Loretan, Subhanjj and Chan, 2009). Insurance companies and pension funds operators maintain investment portfolios in trust for their customers, both individual investors and companies. These investments could be strategically managed either by in-house personnel or delegated to external asset managers. According to a report by CGFS (2007) which was set up to monitor global financial markets for central bank governors of the G10 countries predicted that there shall be an increasing demand for external asset managers’ services.
2.11 Insurance companies, Pension Funds Operators and Real Estate Investment
In recent years capital growth benefits, steady income and higher expectations of investment returns are progressively driving long-term investors to real estate as an alternative investments even though generally, alternative investments generally have lower liquidity as they sell in less efficient markets and require a longer time horizon than publicly traded stocks and bonds. Investments in real estate also help to promote sustainable economic growth and establish wider social benefits (Schwab, 2010). In many circumstances, investors consider real estate as a suitable choice in alternative investment portfolios.
Real estate investments are attractive to insurance companies and pension funds operators because an investment in the asset class can assist in providing duration hedging. It is expected that these investments generate attractive yields above what is obtained in fixed-income market but much higher volatility. Property developments are undoubtedly long-term investments which could that could equate the long duration of pension liabilities. Furthermore, real estate assets could hedge the sensitivity of institutional investors’ liabilities to increasing inflation (Braun et.al 2014).
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