Fund of funds products and multi-manager accounts are old news for the wider investment industry, but are relatively new options for real estate investors.
The European unlisted funds market has only really taken off in the past five years, so it has taken a while for the critical mass of funds to be created for a multi-manager approach. The UK market has been a step ahead of the rest of the continent, mainly due to its longer history of pooled vehicles.
The current landscape is divided between fund of funds products, pooled funds which invest in other pooled funds and multi-manager accounts, where an investment manager invests in a range of funds on behalf of a retained client. The picture was previously slightly confused as many in the industry referred to both approaches as fund of funds, but the fund of funds / multi-manager differentiation is now generally accepted.
In the UK, Merrill Lynch Investment Management, ING Real Estate Investment Management and Schroders all manage fund of funds and multi-manager accounts. Henderson Global Investors and Morley Fund Management have significant multi-manager businesses.
Aberdeen Property Investors last year launched the first pan-European fund of funds, although some have argued it is not a true fund of funds, as, at present, the investors are a club of the five Nordic investors already involved in the vehicle. Former MN Services head of real estate Erwin Stouthamer has launched a fund of funds vehicle for Europe and one for Asia with his new Composition Capital Partners business.
Stouthamer says: “Now is a good time to launch
a fund of funds product. Investors understand
the idea of a real estate fund of funds having seen them in other asset classes and there has been an enormous expansion of private funds in Europe.
“Especially for small pension funds, it is very hard to identify the best sectors, the best funds and the best managers from nearly 400 funds in the INREV database. A specialist fund of funds manager can also give a client access to closed funds.”
However, the fund of funds approach is not just for the smaller investor. The first investor in Stouthamer’s funds is a major institution from outside Europe which has invested e75m across both funds.
These first forays into fund of funds are likely to be joined by a host of others this year. Managers such as Henderson, Morley and Healey & Baker Investment Management are understood to be looking at such products.
Nick Cooper, managing director and head of indirect investment at ING REIM says its UK fund of funds and multi-manager business is its fastest growing sector, with well over e1.5bn under management. “The demand comes from smaller pension funds who are looking for an exposure to real estate but do not have the critical mass.
“Many of these smaller funds find it hard not just to build up a direct property portfolio but to build up a diversified portfolio of investments in pooled funds. There are a lot of funds out there and it is hard for a small pension fund to justify the time and expense it takes to rate them all.”
The European market for un-listed property funds is still highly opaque and although INREV has improved transparency, it still has some way to go. Just to build up and maintain a database of funds currently available for investment is very time consuming and it is critical to continuously meet the teams and listen and compare stories in order to distinguish a unique strategy or a unique team from those less so.
Another part of the problem is the strong
competition between investors to get their cash away. A small pension fund will find it hard to invest e5-10m in a pooled fund when it is competing with large funds investing e25m and more. However, an investment manager investing on behalf of a number of such clients can get the money invested.
Institutions are not the only investors who can benefit from a fund of funds approach. High net worth individuals - many of whom may have as much to invest in real estate as a small pension fund - will get the same advantages. And some investment managers are looking at how they
could get private money to flow into their fund of funds product. This could be done by creating a feeder fund with a low minimum entry or by
teaming up with an bank which has a strong
distribution network.

There are some potential problems with a fund of funds / multi-manager approach. For example, what is to stop and investment manager putting multi-manager clients into funds run by his company and getting two sets of fees out of them? Cooper says there are usually restrictions on the amount available for investment in the managers own product but also points out “If your product has clearly been the best-performing, you aren’t acting in clients’ interests by keeping them out of it.”
Stouthamer says: “One of the most important differentiators in the future between fund of fund managers will be independence. Investors will want to be reassured that managers always pick the best funds.”
There is also the question whether a fund manager should be able to have access to information about a rival’s fund into which he is placing multi-manager clients’ money. “This is the sort of thing good management practice and Chinese walls can sort out,” says Cooper.
There is also the question of the double fees, both on the fund of funds and its investments. Stouthamer says fund of funds fees tend to be lower than on direct real estate funds as they do not require the same level of infrastructure. “To run a cross-border fund you need a lot of people and multiple offices,” he says. “Obviously you are paying fees to go into a fund of funds, but in return you get expert knowledge, both in terms of fund selection and in managing the investment. To select and manage a portfolio of unlisted funds in-house also incurs costs.”
Some smaller pension funds have chosen a different approach, especially if they are only looking for domestic exposure to real estate. Earlier this year, the £640m (e941m) Gloucestershire County Council scheme invested £45m, its entire real estate exposure in the Hermes Property Unit Trust, which gives the fund exposure to around £500m of UK property.
Bob Potter, director of finance at Gloucestershire County Council, says: “HPUT offers Gloucestershire an ideal diversified exposure to the UK commercial property market and Hermes has a strong track record as investment manager. Furthermore we have been attracted by HPUT as the lowest cost solution.”
However most multi-managers would be suspicious of this approach. Jenny Buck of Schroders, who manages £650m of multi-manager accounts, says: “One of the most important things about the multi-manager approach is that it spreads manager risk as well as sector and geographical risk. You aren’t reliant entirely on my judgement, but have the benefit of the skills of a several different specialist managers.”
Fund managers buy into indirect vehicles on behalf of clients either at the launch stage or, increasingly, on the secondary market. The secondary market is an informal one; in the UK, HSBC bank is the only non-fund manager to provide a match-making service between investors and funds. Generally, fund managers have taken the lead in trying to create a liquid market.
However, this is likely to change following INREV’s work on liquidity and establishing a secondary market. “Following the UK, there will be a gradual move towards secondary trading in European pooled funds,” says Mike Clarke, head of distribution at Schroders, who has spearheaded INREV’s moves in this area. “However, increased transparency and a less buoyant market will be needed for it to really take off.”
In the UK, the giant retail park fund Hercules, managed by Schroders and Pillar Property, has been the most liquid of the unlisted funds and now has more than 110 investors and sees around £196m of trades each year.

Some fund of fund models
Pan European
Aberdeen Property Investors
The Aberdeen Indirect Property Partners (AIPP) fund was the first pan-European fund of funds. The fund aims to raise e300-400m in its first year, after raising e161.5m at its first closing.
The fund is structured as a Luxembourg FCP, and will invest in eight-15 real estate funds, most of which will be core-plus in style. It is targeting returns of 10-14% annually.
The fund has made its first investment – putting e30m into IXIS AEW Europe's European Property Investors (EPI) fund. The fund is expected to make five further investments before the end of the summer. So far the fund investors have been a small group of Nordic clients of Aberdeen, but it hopes to raise further capital.

Structured as a closed-end company domiciled in Ireland, the fund is targeting a range of “best of breed” core and core-plus real estate funds, in order to provide a diversified exposure to European real estate within pre-defined country and sector allocations.
PREFF, sponsored by Portuguese asset manager ATRIUM, with Oxford Property Consultants as investment adviser, aims to deliver a total return of 8-10% annually, during its 10-year life. The fund intends that a significant part of that return will be delivered through a semi-annual dividend payment of 5-6% annually.
The fund is targeted primarily to institutional clients, including pension funds, insurance companies and foundations. The initial investors were a pool of Portuguese institutional investors, including the Portuguese Social Security, with a 10% stake in the fund, the subsidiaries of two major Spanish financial institutions and one international insurance group.
e58m was raised at the first close and PREFF is targeting a total of e250m through additional closings within the next 12 months.

Composition Capital Partners
Erwin Stouthamer’s Composition Capital Partners has launched the Composition Capital Fund CV, a Netherlands-domiciled pan-European fund of funds, which aims to raise e150m in equity. The fund will invest in seven-10 unlisted funds across Europe to produced a balanced portfolio. It will also look at investing in jvs with local partners. It is targeting 15% returns to investors and so Composition will be looking at value-added and opportunity funds in order to deliver the targeted returns.

Composition Capital Partners has launched an Asian fund of funds, structured along the lines
of its European vehicle and with the same return targets.
Stouthamer says: “Asia is still a couple of years behind Europe in terms of the market’s sophistication and number of funds, but it is catching up very quickly.”

ING REIM’s Osiris fund was the first UK real estate funds of funds, launched in 2003 with a target size of £250m (e368m).
It has an indefinite life and is targeting returns in line with the HSBC/APUT UK pooled funds index. Nick Cooper points out that most fund of funds investors are quite happy with benchmark returns. It has invested in property unit trusts and limited partnerships investing predominantly in UK real estate.

In 2003 Bayerische Landesbank subsidiary Real IS ImmoKapital Dachfonds has launched the first fund of funds offered to German institutional investors.
The fund invests in vehicles such as German spezialfonds, for example open-ended funds for institutional investors; specialised funds in terms of property sectors; and closed-end property funds.
The fund has an estimated life of 15 years, and repatriation of capital is expected to start in the ninth year. The fund is predicted to earn investors a return before tax of 5.5% annually.

Multi-manager: an investor's view
The £715m (e1bn) Bedfordshire County Council pension fund used to have only 2% in real estate, invested entirely in UK direct property. Inevitably, the fund’s management decided this was not a significant amount, effectively worthless in asset allocation terms and a decision was made to invest £50m (7%). Due to the success of the approach, Bedfordshire is now upping its weighting to 10%.
However, after taking advice, in 2001 the local authority fund decided that it would be hard to invest even this increased sum in direct property. Geoff Reader, strategic adviser – pension fund, says: “An amount like £50m can’t get you much direct exposure – it would barely buy a medium-sized UK shopping centre.”
Bedfordshire sold its small direct portfolio and chose ING REIM as its investment manager with a multi-manager approach and a fully discretionary mandate. Now the fund is invested in a dozen pooled funds and has a much broader property exposure than could previously have been imaginable.
“As an example,” says Reader, “We have a stake in the Lend Lease Retail Partnership, which gives exposure to the Bluewater shopping centre, one of the largest shopping centres in the UK. We could never have got exposure to that sort of asset otherwise.”
Reader says he has been pleased with the multi-manager approach: “We came in at a good time and the market has been favourable for all property investors. However, we have outperformed the IPD Index and our manager is set a target to beat the index. It’s been a very straightforward way to invest for a fund of our size.”
He says the multi-manager approach has been considerably easier for Bedfordshire than taking the direct route and also easier than choosing funds itself. “It’s probably been cheaper than going direct as well, but that’s harder to judge,” says Reader.
Bedfordshire takes a sanguine approach
to the question of timing, as all investors have been finding it takes longer to get money invested. “We accept that it will take time for the manager to invest for us, we wouldn’t want the money invested for investments sake.”