Investing locally: The case for residential housing and venture capital

The discussion was facilitated by John Harrison, adviser to the Border to Coast Pension Partnership.

The speakers were:

• Harry Raikes, Private Equity Investment Director, Schroders Capital
• Chris Santer, Real Estate Impact Fund Manager, Schroders Capital
• William Bourne, Principal, Linchpin Advisory
• Keith Bray, Forum Officer, LAPFF
• Laura Colliss, Pension Fund Manager, North East Scotland Pension Fund
• Nick Dixon, Head of Pensions, Avon Pension Fund
• Jeff Dong, Deputy Chief Finance Officer and Deputy S151 Officer, City & County of Swansea Pension Fund
• Mark Gayler, Head of Pensions and Investments, Devon County Council
• Sean Greene, Head of Pension Fund, Lancashire County Council
• John Jones, Independent Pension Board Chair, Dyfed and Tower Hamlets pension funds
• Matthew Trebilcock, Head of Pensions, Gloucestershire Pension Fund

John Harrison: Welcome to our roundtable about local investment. Together with Schroders, we’ll be looking at two ways to invest locally. The first is through residential real estate, which can be very local to a particular fund or pool and intersects with impact investing. The second is through UK venture capital. Chris, would you like to begin on the residential side?

Chris Santer: Impact is a good spirit with which to drive local investment. The government has been clear that we need more capital to make a difference to the UK, be it in specific regions, areas, counties. We’ve been looking at those investments through this impact lens.

When considering where to deliver impact, residential housing is a compelling case. There are 1.3 million households waiting for social housing, and it’s bankrupting local authorities. We’ve had two government bailouts in 10 years. The UK government can no longer do this. That is a strong tailwind for more private capital and liquidity invested into both local and impact.

There is also alignment between impact investing, residential real estate, and local investing. One of the features of real estate that you can point to it; it’s in a specific place. Investing in a specific place doesn’t necessarily mean you’ve made local improvements alongside having generated returns, but there is an enormous amount of overlap with impact investing.

Considering impact alongside financial return, we look through the five lenses of impact:

1. What is the intent of the investment? For example, to deliver more housing, generate more jobs, regenerate a town centre – alongside offering a return.
2. How much impact can we deliver? We want it to be a tangible metric that can be tracked.
3. Who are the target beneficiaries? The residents, the users, the local community need to benefit as part of the investment, and that is one area where we see the overlap with local investing.
4. What is the contribution of our investment? In other words, what can we deliver that wouldn’t have otherwise happened?
5. And finally, what are the risks of what we hope to achieve? Investors don’t need to give up returns to do impact or residential investing; it’s a different risk-reward relationship. It can be lower volatility and therefore may come with a lower return.

Viewed through those lenses, these investments are perfectly doable and measurable, and can form different parts of investors’ allocations.

John Harrison: What is the scale of a typical project?

Chris Santer: There is a lot of nuance, and it depends on the size of the capital that we have to commit. Sometimes, if you make local investing too specific and in too small an area, it can be difficult to attract other capital and can become expensive, because there’s a certain cost to doing these things regardless of scale.

John Harrison: Harry, you’re here to talk about venture capital as a form of local investing. How does that work?

Harry Raikes: We’ve long believed that there is a great potential for a UK domestic institutional fund, but we’ve struggled to have the capital and the investor interest to be able to execute against that idea. When it comes to venture capital, the UK has phenomenal talent. People do not talk about it enough. The UK is the third largest market globally, the largest singular market for venture capital in Europe, and we’re raising great entrepreneurs who are creating great companies.

As one example, look at Revolut, founded in 2015 by an immigrant to the UK of Ukrainian/Russian heritage, and most recently valued at £45bn, with huge global institutions buying secondary from employees. What that entrepreneur has created is phenomenal. It’s a true global success story.

The frustration is that the great funds that are finding these great entrepreneurs at the early stage are almost all US institutions. They come over, they’ve got visibility on these companies, they put on a good pitch, they win the round and the company raises loads of money. That success is stolen by international investors.  

We’ve designed our fund strategy with a 25% allocation to early stage funds, partnering with the best early stage managers, with the remaining 75% to be an option for the best companies emerging from those portfolios. It’s about having access to those opportunities and getting a slice of the pie. It’s important that we’re not trying to push other investors out because, in the UK, we don’t have a whole lot of scaling experience. That is something that the US is particularly strong at, and we still need that expertise. It’s a partnership approach and being a local seat at the table to share in that potential.

John Harrison: Bringing in the rest of our panellists, we’d like to consider how these local investments work in practice. Where does local investment fit into your allocations? Are the associated resources found at the fund level or the pool level? And, what does local mean to you?

Mark Gayler: Back in the era of the previous government’s levelling up agenda, our committee decided that we should make an allocation to local impact. We allocated 3% of our fund, which we sliced from other private market allocations. We wanted it to be local to the South West.

We found that some of our colleagues were much more locally focused and wanted to do their own fund area. Gloucestershire wanted to do housing in Gloucestershire; Avon wanted to invest in Avon. We decided, if that’s the case, we’ll try investing in Devon as well.

We’ve made these investments ourselves, outside of the pool. With all the proposals going on now, it may well be something that we hand over to the pool to manage for us in the future, but we followed our own process to find investments.

We have invested in two UK affordable housing funds. In one case, they’ve given us a side investment in Devon; in the other case, it’s a whole-UK fund but they have agreed that they will only take half the investment when they are investing in Devon. We also have a sustainable infrastructure fund where they’re setting up a side pocket, so half the investment will be in assets in Devon.

In terms of venture capital and private equity, we’ve committed to the Foresight Regional Fund that’s being set up for the South West. That will be investing in small and medium sized businesses. We may do more [venture capital investing], but going forward, we expect we will want to do that through the pool.

Nick Dixon: Interestingly, what Mark has described is very similar to how we think of local investment, too. When we think of local, we think of regional, meaning the South West. We actually don’t think of Avon, since Avon is a slightly amorphous area – the legacy of the council abolished in 1996. So it’s regional, but you want to have some local stories to tell. So, considering a housing fund serving the South West, we will want some of those houses in our local area and then there’s something that we can talk about.

In terms of sectors, we’ve split it into three areas: community, growth, and environment. Community is primarily about affordable housing, growth is about small to medium enterprise funding, and environment is about clean energy.

Any impact must be tangible. For example, if we’re looking at affordable housing, we need to solve a problem in the city of Bath where there is a very wide commute radius for NHS staff. We want to provide social benefits that are tangible, such as reducing the commute radius – if nurses are living in accommodation next to the hospital rather than coming in from South Wales. What’s their rent as a percentage of the local market? How does that impact retention of staff? These are tangible sociable measures – they aren’t theoretical. All of those types of investments fall into our 3-4% allocation to local investment, but it’s slightly untidy as some fall into different categories in terms of measuring risk and return.

In terms of where the resources are located, I think our role in the LGPS fund is to bring forward ideas, working with mayoral authorities to find them. The investment decisions ultimately must be made in the pool, because they have the expertise with fund managers.

Jeff Dong: We take a different approach to some of our peers. It sounds as though some of the other panellists take a top-down approach, as they have local opportunities across private equity, residential housing, infrastructure. We don’t take that top-down approach. Our approach is very much opportunity-led, given the economic challenges in Wales. It’s about finding investable, impact-led opportunities and trying to fit them into the portfolio.

For example, one of our first impactful local investments occurred when an investment manager – Schroders Greencoat – came to us with an investable opportunity in a biomass plant just up the M4 within our geographic boundary. We did the due diligence and invested in it. We take it to be among the most positive investments we’ve ever made in terms of engaging local stakeholders including employers, committee and board members and scheme members because you can see it, touch it, go and visit it and see the local employment, local economic contribution and see the real tangible positive impacts it has in terms of the fund’s net zero ambitions.

We’ve long held an ambition to incorporate affordable residential housing but we’ve fallen at the last hurdle on many occasions trying to find opportunities in Swansea, because the overarching consideration is maintaining our investment discipline. We only want investment-grade assets within the portfolio, so there have been many false dawns in that respect. However, we’re in the final stages of due diligence on a £50m Swansea partnership, investing across a whole range of social infrastructure, including affordable housing, so that may change.

 

John Harrison: Laura, how do you view local in Scotland?

Laura Colliss: In Scotland, there is the same desire for funds to invest locally. The definition of local is different depending on which stakeholder you ask. For me at Aberdeen City Council, we cover the Northeast. I wouldn’t want to focus just on the city.

The government has recently put pressure on England and Wales to invest locally, but we’ve always felt some pressure to invest in Scotland or locally. That pressure was always there; every councillor in your area has a passion for something. It might be to regenerate the city, to regenerate a certain building, something else. There’s nothing wrong with that, but they have to be appropriate for your fund.

It’s very difficult these days, when funds are well funded and don’t need to take additional risks when it comes to property development or regenerating areas. It comes down to fiduciary duty and we’re quite open to wanting to consider social housing, for example, but those opportunities need to be brought to us. We don’t have the resources in-house to source those deals and we need someone to come to us with a proposition that is investable and appropriate for the fund.

That’s our position on residential housing. For private equity, we have invested globally – in North America, Europe and the UK – for decades and will continue to do so. Venture capital has been a part of our allocation. I don’t see why we wouldn’t seriously look at the UK when it comes to private equity or venture, but it can be more challenging to find the appropriate opportunities.

William Bourne: It’s interesting to hear all these perspectives, because my clients generally view local in one of three ways – and it’s very different for all of them. One type of client has been, historically, really anti-local investment, because they’re worried in case it leads to conflicts of interest. They’re going to have to change their tune.

At the other end of the spectrum are clients from a very distinct cultural area that are really keen on local investments and have made a number of them, across both social housing and private venture capital, but they haven’t gone particularly well. They didn’t really work and they look up a huge amount of time and resources.

I think a more sustainable, better approach, which is the remaining third of my clients, is to view local investment as the area of the pool. The spin on that is, in Manchester, they view local as the UK but with a stipulated minimum within the region. That gives the advantage of diversification, because for some regions such as Wales, if you only invest in Wales, you don’t get enough diversification.

Mark Gayler: The conflict-of-interest point is interesting. We’ve tackled that by making sure that there’s a fund manager between us and the investment – they make the decisions, not us.

Equally, we’ve made it very clear in each case that we do not want to invest in something unless they have other investors, because that gives surety that they’re not reducing their return expectations or increasing their risk threshold just because the investment happens to be in Devon.

Matthew Trebilcock: If we look at real estate as an asset class, we know the government’s mandate is to build houses, so to say that there are no opportunities at a local level is a myth. When we spoke with managers, we said we wanted to deploy money into Gloucestershire. The vast majority came back and said ‘yes they could’ and there is a lot of opportunity in Gloucestershire, but we’ve had never really looked at that area before. I think actually that’s some of the problem – it’s easy to overlook areas and just focus on the major conurbations.

In the SME space, it might be that we define local as something that would benefit Gloucestershire as an area rather than be geographically specific..

Our fund is not set up to do these things directly. I don’t think that’s the route we should ever go down. What we can offer as a und is considering what is needed in the local area, but leave the operational implementation to those with the expertise.

John Harrison: John, do you think that the funds are well placed to be able to do the analysis?

John Jones: We look at local as regional, meaning pool-level, because I’m concerned that if local is too small an area then you get distortions in the market and may make investment decisions for reasons that are not purely financial. That applies both to residential housing and venture capital.

In terms of the analysis, I think it needs to be pool level, unless you can invest in staff at the funds to do it, but I suspect that expertise is not as readily available.

Sean Greene: I agree with that. We don’t have sufficient resources to do it at the fund level, and we partner with LPPI to do the due diligence. We also rely on external investment managers to bolster sourcing of opportunities. However, we think of local as local – it means within Lancashire. Our existing investments are mostly in real estate, be it retail parks or student housing.

John Harrison: Keith, what about in Warwickshire?

Keith Bray: I haven’t sensed any enthusiasm at all in Warwickshire for this. I think it’s based on the fiduciary issue, a pension fund should pay pensions, so it’s a traditional take. Locally, they consider time. If the investments are small, the management time is not commensurate with the return, then it’s out of proportion.

John Harrison: Thank you for those perspectives. Chris is going to talk about the opportunity set.

Chris Santer: t’s enormous. Just in the microcosm of housing, there are 1.3 million households in England alone waiting for social housing. It’s an enormous number, all of whom need modern, purpose-built, energy-efficient housing, characteristics that help from the environmental and social points of view. The return and impact sit side by side. Ours is an impact fund, so I am trying to address a social challenge and deliver good returns. The two are perfectly compatible.

At the moment, however, there is an absence of the capital and a mismatch between what capital there is and where it’s needed. We aren’t constrained by the planning process or capacity to build – we’re constrained by capital. Once a week we get new investments landing on our desks. The housing associations in the UK are in a terrible financial bind, everything’s stalling, there is a bottleneck. There’s a need and opportunity for other capital to come in. We’re hoping, given the benefits, that LGPS funds will come in to meet that demand.

Harry Raikes: On the venture capital side, we don’t see a lack of capital. The constraint is accessing the opportunities. We’re very bullish on venture in the UK; again, people don’t talk about the successes of British entrepreneurs enough. However, those great returns have mostly been for US investors. Very, very few UK institutions have benefited.

Evidently, access is the most difficult thing in venture, because it’s about the power dynamics of a very small percentage of companies generating the overwhelming share of performance. A US institutional fund can come over to the UK and meet all our best companies in one day, put term sheets out, and have exposures to those companies.

Access for domestic investors is about making the case for a UK fund that is backed by domestic savers. It’s about making the case that we should have a seat at the table, we have value to add, and we should get a slice of the pie in potential future funding opportunities. Our strategy is to partner with these groups, because we are an investor backed by British savers.

We can help international investors in ways that are unique to how we operate, and so we’d appreciate a seat at the table. It’s not to say that, in time, those capabilities won’t be built out locally so that we can then help a company scale through every stage and create an Nvidia or a Microsoft based in the UK, but that’s something that we need to do in time.