Dutch national airline KLM has three pension funds – for its ground crew, cabin crew and cockpit crew. The funds are managed by Blue Sky Group, which was formed in 1999 by outsourcing a KML internal department.
Collectively, the three funds have a capital value of around e10bn. Their average asset allocation to real estate is 12.5%. Blue Sky’s real estate strategist, Raymond Satumalaij, spoke to Ashley Nield

Do you tackle each KLM pension fund’s property allocation individually or collectively?

From a fund point of view they are three separate entities, but we try to treat them in the same way as possible. In the past we used to have investment committees asking us “how come our returns are different when we’re all holding real estate?” Naturally, we want to avoid that as much as possible so we take a common approach.

Have you come to the industry from a pensions or real estate background?

My background is more real estate. I worked at ING Real Estate and then moved to the Dutch building industry pension fund and then to Blue Sky shortly after it was created in 1999.

What percentage of KLM’s pension portfolio is dedicated to real estate? Do you feel this is the optimum amount?

It’s a 12.5% average: ground and cabin staff have 10% and the pilots 15%. Establishing the optimum percentage is obviously one of the big questions that institutions wrestle with. We looked at it especially from a liability point of view. We see real estate as a way of dampening the volatility of members’ contributions (because if it’s reducing the volatility on returns, it’s reducing volatility on the necessary contribution level). It also dampens swings within the portfolio.
We calculated that an additional 5-10% allocation would not reduce these volatilities any further. That’s how we arrived at our optimum allocation.
At the end of the day, real estate, like any of the other asset classes, is just a means of achieving the liability call.
What kind of benefits do KLM’s pensioners enjoy?

Pensions are defined benefit, conditionally index-linked to inflation. We look at real estate and ask whether it’s a perfect hedge against inflation. It really depends how you measure it. We look especially at the total return, and we believe in the inflation hedge concept if real estate markets are in balance. But often they’re not, so we mainly use inflation-linked bonds to get the hedge.

How does Blue Sky’s real estate facility position itself in the investment marketplace?

We were first a department within KLM and then they outsourced our organisation. We looked at our strategy and how we would implement it and said we wanted to be specialists at strategic asset allocation. It was one of the things in which we could add most value to our clients. Within that context we decided that stock-picking was not that important. For real estate that meant we wouldn’t invest any more in bricks and mortar because that’s the property equivalent of stock-picking.
We decided to go purely indirect, investing through unlisted and listed funds.We sold our directly-held US real estate and started investing in the US REIT market. Within Europe we had a direct Dutch portfolio and – in conjunction with the Dutch side of steel company Corus (Hoogovens) - we created the Altera Vastgoed fund. That’s how we got our indirect exposure in the Netherlands. We’ve also participated in European real estate securities and these three areas now constitute the major parts of our portfolio.
For just under two years we’ve been investing in unlisted funds in the US where we’re looking for core real estate private funds because we think that in current markets the thing we’re going to be hurt by most is appreciation. When you go into the opportunistic arena appreciation is the major component of your return. But on the core side you can still enjoy income even if appreciation falls behind.

Do you regard your holdings as
diversified or sector led?

At Blue Sky Group we’re five or six years down the road and our investments tend to be quite diversified. As a start that’s not a bad situation, because, at the end of the day, it’s all about exposure.
You can’t deny the value of looking at sectors because to a major degree they determine your returns, but it’s more from a ‘thinking’ framework at the moment. In practice, in the US and Europe it’s difficult to find specialised funds which are sizeable enough and have a core focus. The next stage – we’re not there yet – is where we look at specialised segments if they are available and implement a strategic allocation to sectors. But as an investor if you say ‘I’m only going to invest is this and this sectors’, you will encounter a lot of operational issues and I think it will take five to 10 years before your portfolio is ready.

Will the emergence of UK and
German REITs affect your allocation dramatically?

It depends on how far they go. In the US they have public and private REITs. In Europe, even with monetary union and the choice of whether I invest in the Netherlands or the UK, I always have to look at the tax differences between a UK and a Dutch pension fund. By creating these transparent vehicles politicians will increase investment in Europe as a whole, but the question is exactly where the benefits accrue. The politicians’ dilemma is whether they should think of Europe as a whole or their country first. I don’t see this happening in the short run.
What drives your investment search: Yield? Diversification? Volatility?

In the current market we’re mostly looking at yields. Yield is something you can focus on and measure.

Does the head of investment put
pressure on you to find a yield margin over and above, say, treasury bonds?

Luckily not. One thing that makes Blue Sky different to other managers is that we have quite a small investment team with a very open discussion framework. We have two-weekly meetings with our equities and fixed-income colleagues where we discuss real estate issues within a financial market context and take views. At the end of the day it’s all about the liabilities of the pension fund: it’s not about my asset class being the best, it’s about the combined assets growing properly for our clients.

How are the pension funds performing in terms of assets to liabilities?

The KLM pension funds have quite a substantial surplus of assets to liabilities. That makes the work here quite different: a lot of pension funds which have solvency ratios of less than or around 100 are seeking to ‘announce’ their returns and one of the things they’re saying is that real estate can play a part in this. That means extra pressure on the real estate manager to deliver. One of the things we avoid in our investment strategy is investment pressure.

How much use do you make of
financial instruments such as
property-based derivatives?

We’re looking at the liquidity and pricing of these instruments and they’re not perfect. They don’t have to be perfect for us to get involved, of course, but there has to be some proper pricing and we don’t think the industry has got there yet.

Do you handle all the investing
in-house or make use of third parties?

For real estate securities we use third parties, but on the unlisted side we don’t think that there are any proper managers. We aim to be a specialist asset allocator, making the right decisions on the basis of the information we get. But what we see is that there is no real alignment in the unlisted side between the investor and the fund manager.
Transparency is part of the story but in general what I think is missing is proper communication between the fund manager and the investors.
For example, I’m not an expert on UK or Spanish real estate – that’s the fund manager’s role, but what he has to do is communicate his responsibility to me in the proper way. And that’s where they’re always lacking and hiding a bit.
They say: “Well, it’s a limited partnership and as the general partner we are responsible,” but that does not absolve them of the responsibility to keep shareholders fully informed and up-to-date. In the current market it’s easy for fund managers to attract capital so they don’t feel obliged to improve.
We’re always looking for managers who want to listen to what we are saying. It’s not as though they always have to obey us but it’s important that we have a healthy conversation about it. Then they can decide what they’re going to do.
That’s maybe the difference between the current market and the way that it was 10 to 15 years ago. There are now a lot of indirect real estate investors who are knowledgeable, as opposed to pension fund boards relying absolutely on what the manager is saying.