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The Actuary The magazine of the Institute & Faculty of Actuaries
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Soapbox: Robert Gardner: An open door for pension funds

One of the biggest advantages that pension funds have over other investors is their long-term investment horizon — this translates into their ability to invest in less-liquid assets that are not appropriate for investors with shorter-term liabilities. They also need assets that give them protection against inflation, something that many are worried about following the injection of £200bn of central government funds through the process of quantitative easing. A potential asset that ticks both these boxes, and offers an attractive pick-up over linkers, is social housing debt.

Social housing, partially funded by the government, provides housing to low-income families that cannot afford to rent or buy property in the private sector. It is generally provided by local councils and not-for-profit organisations such as housing associations, or registered social landlords (RSLs). There are around 1,700 RSLs in England and 90% of the stock, namely social rented units, is owned by 18% of them.

In England, the RSLs are regulated by two agencies, the Homes and Community Agency (HCA), which deals with funding and regeneration work, and the Tenant Services Authority (TSA), which is responsible for regulation of all social housing providers. RSLs’ activities are financed by the rent and service charge payments made by, or on behalf of, those living in its property. Guideline rent levels are set by the government and the usual guideline limit on rent increase is RPI+0.5%, ensuring that the cash flows that RSLs receive are inflation-linked. Often, the tenants have no income and therefore receive housing benefit, which is paid directly to the RSL from the government body. Thus rental streams are generally regarded as robust, with low levels of voids and bad debts at 2.1% and 1% respectively, suggesting that there is a continued strong demand for the properties and good performance on rent collection.

Traditionally, the HCA issued RSLs with partial government grants for new projects on the back of which the RSLs secured LIBOR-based lending from both major banks and building societies. However, following the collapse of wholesale lending (post- Northern Rock, September 2007) and the higher capital ratios required by financial institutions, such lenders are in scarce supply. The government, having previously promised that one million of the three million new houses due to be built by 2020 will be at ‘affordable’ below-market rates, has indicated in its 2010 pre-Budget report that the social housing budget could be slashed by as much as 18%. The National Housing Federation has warned that such cuts could mean that 556,000 affordable homes, which are categorised as more expensive than council properties but priced below market rates, would not be built. How can the HCA tackle this funding shortfall?

A potential solution is for the individual inflation-linked rents from tenants to be gathered up, structured into tranches, wrapped with a rating (typically A or AA) and issued as a series of inflation-linked bonds. The issuer of such bonds could be either the individual RSLs or the HCA (see Figure 1).

These bonds are then sold on to UK pension funds and other institutional investors at an attractive pick-up over similarly dated linkers. Through this type of structure, pension funds are able to access the secured, long-term, inflation-linked cash flows they crave, while at the same time providing social good and much-needed long-term funding to RSLs/HCAs.

Anyone interested?
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Robert Gardner is co-CEO and lead investment consultant at Redington