Traditional architecture stands above a shopping street in central Copenhagen, Denmark. (Photographer: Freya Ingrid Morales/Bloomberg)

A $76 Billion Fund's Growing Bet Shows Normal Is a Long Way Off

(Bloomberg) -- The largest commercial pension fund in Denmark is making a big bet on real estate as it adjusts its portfolio in anticipation of very low interest rates for a very long time.

Michael Bruhn, head of real estate at PFA in Copenhagen, just spent more than $1 billion on property in Germany as he adds to a real estate portfolio that’s now worth over $9 billion.

It was PFA’s biggest property purchase to date and follows a recent decision to “significantly increase” exposure to that market through 2022. Bruhn says that’s roughly the time frame over which the fund is anticipating interest rates will stay about where they are now.

Based in Denmark, PFA operates in a corner of the world that has had negative rates longer than any other country. The Danish central bank first cut its main rate below zero in mid-2012. Back then, the extreme policy was deployed to fight back speculators hoarding kroner during Europe’s debt crisis. But negative rates have proven hard to exit and Danske Bank now warns that the latest wave of uncertainty in Italy and Turkey is likely to keep Danish rates low as money heads for the safest markets.

For investors, that means that the return to more normal market conditions might be further away than they’d perhaps hoped. Bruhn says PFA is now keen to expand its investments outside Denmark in an effort to generate higher returns.

“One third of the PFA balance sheet doesn’t produce any interest or any returns,” he said by phone. That includes Danish and German bonds. “They’re just sitting there. So we’re constantly seeking new ways to find income and, of course, balance it with the risk as well.”

PFA decided to invest in commercial and residential properties in Germany even after that market’s significant appreciation in value in recent years.

“It’s not cheap to buy German residential,” Bruhn said. “It would have been better buying these assets 10 year ago -- you know, hindsight -- but it is what it is and we do have to do the best we can for our customers at any given time.”

Property was the asset class that performed best in PFA’s first quarter, with a return of 1.5 percent, its latest figures show. Its portfolio of listed shares fell 2.9 percent in the period and its bond holdings delivered a 0.4 percent loss.

Investing in Denmark’s most liquid market -- its roughly $420 billion in mortgage-backed covered bonds -- entails in many cases paying borrowers. The interest rate on loans that are refinanced each year was minus 0.13 percent, in auctions now under way at Nykredit. (The record low is minus 0.23 percent, reached in 2017, the bank said.)

A $76 Billion Fund's Growing Bet Shows Normal Is a Long Way Off

Investing in bonds made good sense before the financial crisis, but not anymore, according to Bruhn. He points out that the spread between returns from what he calls “core German residential” investments and 10-year government securities is as high as 250 basis points.

“That’s historically big,” he said. Bruhn says that even if interest rates do go up, real estate offers a hedge because rents tend to rise in monetary tightening cycles.

PFA is also looking at Asia to find higher returns. “We are doing opportunistic investments in China,” Bruhn said. “It’s the second-biggest economy in the world. It has one of the highest growth rates. There are future opportunities if you have the value-add or opportunistic style money so I think it would be a mistake for us not to invest in China.”

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