Best Dutch fund - Blue Sky Group

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Pioneering a way to run a real estate portfolio using a property index is the achievement which has earned the Blue Sky Group the Best Dutch Pension Fund Award.

Having to manage a portfolio of direct holdings in real estate as well as some shares in property companies from the KLM corporate pension schemes, Blue Sky advised KLM to diversify the portfolio away from the Netherlands where most investments were concentrated and switch to indirect holdings.

Blue Sky Group organised a merger of the KLM portfolio of properties in the Netherlands with another Dutch pension fund and had it managed externally in partnership with Altera Vastgoed,.

But the vast majority of the €1bn real estate portfolio was ultimately to be sold.

The pension fund then had to decide on investment styles and opted for a passive, rather than active, approach.

It did so because it says that active fund managers can underperform the benchmarks for a substantial period. If this were to happen with the fund's managers, and its trustees decided to take the portfolio elsewhere, the search for new managers would take time. However, having a passive investment strategy in place means that that can be used to run the investments while a new manager is being selected.

Blue Sky Group also says that active management of real estate stocks is hampered by lack of breadth in the index, the skewing in the index constituents, the different legislative frameworks and market practices in different countries. This makes it difficult for active managers to outperform the benchmark.

Because of the lack of managers offering passive products, Blue Sky Group decided to create its own customised benchmark.

As a basis for its European real estate portfolio, it chose the Global Property Research Index (GPR) 250, run by Kempen Capital Management.

The index is made up of European companies within the GPR 250, but with the UK weighting reduced to 20% because the standard UK index weighting was considered to be too high a concentration. However, within this real estate portfolio, all the UK sterling risks are hedged.

Blue Sky Group carried out extensive research into the best way to replicate the index. Because property is such an illiquid asset, the fund uses an index sampling method to track the benchmark. For the fund, the greatest challenge was how to find a sample of the real estate index which was liquid enough to allow it to run the portfolio in an efficient way. The key requirement was to make sure it would not be forced to sell funds if the index were to change.

In order to select the sample, the fund carried out a study to find the smallest number of stocks with the highest liquidity. It then investigated issues such as how that segment performed in relation to the benchmark.

In the end, there were between 35 and 40 stocks in the index which met the criteria.

Blue Sky Group says the objective is to have a portfolio tracking error of no more than 2%. In practice, it says the tracking error is much less than that.

The fund started to sell off its real estate portfolio in 1999, first disposing of its US properties which it replaced by REITs. Blue Sky Group's first passive real estate investments in Europe were made in 2000.

At present, the allocation to real estate is split between private unlisted real estate in Europe, predominantly the Netherlands (25%) and 35% in public real estate securities investing in Europe, through both property and REITs. The other 40% is invested in the US, with 35% of this in public US REITs, and the remaining 5% in private US REITs. However, the US portion includes both active and passive investments, as the US is a more mature market.

Blue Sky Group's award has been made for its continued excellence in managing most of its real estate holdings on an indexed basis.

For Blue Sky Group, indexing has also brought benefits in the form of lower management and transaction costs. Blue Sky Group says the average management fee has gone down to 40 or 50bps in its semi-passive portfolio, from 100bps for investing direct.

It also says the returns from its real estate portfolio (after expenses) are as good or better than the indices being tracked, and also compared with active managers. In 2005, the return from its European real estate securities portfolio was 26%, and 38% in 2004.

Furthermore, the real estate segment of its overall portfolio has now been invested up to the intended 12.5% of the total fund.







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