Speaking at the Winter Forum on Real Estate Opportunity and Private Fund Investing, Bryan Bailey, portfolio manager, real estate for the world’s largest pension fund, the $160bn Calpers (California Public Employees Retirement System), explained that the fund’s current real estate allocation was 7%, lower than its 9% target. Calpers’ investment committee is aiming to increase the funding level back to its target, although there is no pressure for the fund to do this in the short term.
To this end, Bailey points out that the fund has almost $3bn of funds to put out for equity in the real estate market. “With leverage of 50% this represents about $6bn that Calpers has to put in real estate today.”
The fund operates 46 partnerships with property investment managers, overseen by 14 professionals and eight support staff within the fund.
Looking back at the historical use of real estate by the fund, Bailey explained that before 1998 Calpers had used fee advisers only for real estate deals. This strategy changed, he noted, in 1998 when the fund introduced a policy of more closely aligning its interests with real estate advisers.
“What this means is that we have a strategy of co-investment, dedicated teams and performance-based fees for real estate. At the same time it also means that we allow more discretion to our advisors. I think this has helped Calpers react to the market better. When we are not sleeping well at night then neither are our partners and I think this has been a good strategy for us.”
The fund’s total real estate portfolio allocation represents some $11bn, of which $3bn is invested in “non core strategy”, which Bailey says includes timber, vineyards and single housing investments, where Calpers has over $1bn invested. “Calpers has built over 40,000 houses in California alone since 1992,” he says.
By sector, however, Bailey points out that exposure to industrial property is the largest within the plan sponsor’s real estate allocation. And, in a new direction for the fund, he notes that opportunity fund investment has become a significant focus in the pursuit of returns: “Calpers was a direct investor for so long, but in the last year we invited opportunity funds to come and make proposals to us.
Investments the fund has made in the opportunity sector include allocations to:
q Aetos Capital Asia, a 100% investment in Japan targeting non-performing (NPLs)
q DIVCO, investing in technology related areas buying distressed high-tech properties for releasing and repositioning.
q Hampshire Companies – a 100% investment in northern New Jersey/New York with a value added strategy for industrial, office and retail.
q Hines European Development Fund – Investment in Western Europe, primary in the UK, France, Italy, Germany and Spain. The 100% leverage strategy is to develop and rehab office and industrial properties for sale – 85% office and 15% industrial.
q Deutsche Bank, alongside sister fund Calsters, (Californian State Teachers Retirement Fund) – 72% investment in Europe, 15% Asia and 13% Americas. Redevelopment and repositioning of assets, loans and operating companies.
On the same platform, Thomas Mizo, commissioner at Lacers, the LA city employees retirement scheme, and also a managing director /partner at real estate investment firm Chadwick Saylor, explained that being on a pension board had given him a true appreciation of how pension funds are run: “One of the things I’ve learnt is that the goal is not to hit home runs for all of our investments, it is to diversify our portfolio and make sound and prudent investments and to meet long term actuarial assumptions.”
The Lacers fund, he explained was created 60 years ago by city charter and has a board of seven, comprising three elected members. The scheme has 40,000 participants – 25,000 active and 15,000 retired.
Last year the $7.8bn fund paid out $430m in benefits and Mizo says it is enjoying healthy growth this year.
Overall asset allocation for the Lacers plan comes out at 60% equity – both domestic and international, 20% fixed income, 7% in real estate and 7% in alternative investments.
Regarding real estate, Mizo explained that Lacers’ strategy consisted of investment in commingled funds – via 15 different managers and 20 funds, with one separate account.
“We look at real estate not as an alternative to fixed income but as an equity investment substitute where we can add value to the portfolio and get greater diversity. “Today we have a 7% investment target in real estate, which equates to some $550m.”
A year ago, Mizo said Lacers had been a $6bn fund and with the denominator effect its former 5% allocation to property had risen to 7%.
“This might not seem like a lot, but it is actually a 40% jump and it means we have $200m available to invest in real estate.”
Boring down a bit further, Mizo noted that Lacers takes relatively small bets in property, generally between $10m and $15m in size: “I believe that as we grow we will figure out what we like and add follow up funds with the managers and increase our investments though. For example, we recently we made a $25m commitment to a hospitality fund.”
The fund’s investment process, he says, is predicated on the use of an external real estate consultant who then discusses the investments with Lacers staff before presentations are made to the board of trustees.
Real estate allocation, says Mizo is not dissimilar to other US pension funds, with a high exposure to office (36%) and apartments (30%), mid-range exposure to industrials (15%) and light exposure in retail (5%) and small allocations to hotels and timber.
Geographically, he says, these investments are spread across the US, although international exposure is “very low.”
The Lacers fund also re-evaluated its exposure to the opportunistic sector as a result of the downturn in the equity markets, Mizo notes. “We decided we would look at our real estate and private equity portfolios to see if we were missing out on anything, because we were fairly traditional in what we did.
“We decided to look at areas like senior housing or affordable housing, which were areas that we did not look at in the past.
“Today we’ve decided that we are seeking alpha and that we want to increase returns. We had to ask the city (LA) this year to make a major contribution to the retirement fund because of the economic downturn and we would obviously like to lighten their load going forward.”
As a result the fund approved a policy to invest up to 10% of overall real estate into opportunistic strategies - equating to about $55m in assets. “Strategies we are looking at include style funds, emerging markets, and opportunities in the southern California area.”
However, Mizo was clear that any local investment was fiduciarially sound rather than socially oriented:
“If it has a social benefit then that is great but this is ancillary to our goal, which is to achieve the highest risk adjusted goals that we can.”