Pushing the boundaries
Paul Van Gent
Dutch industry-wide pension fund PME Metalektro has a real estate allocation of around 8% of total assets, with 1% of that in indirect investments and the remaining 7% invested directly. These proportions are not likely to change significantly, says fund manager Paul van Gent.
"Part of the time we are underweight our benchmark, and that is tactical," he says. "Structurally we are aiming for 8-10% in real estate."
Van Gent notes that among the indirect property vehicles that are available to investors, the level of transparency varies. "If it is an indirect investment set up for the benefit of the shareholders, and we can write in the level of transparency we want, then it's perfectly transparent," he says.
Precisely how indirect property investments are structured is of particular importance to PME, since it is now looking to change some of its real estate holdings from direct to indirect. "If we are able to dictate the same terms to the indirect managers as we have on our direct investments then there is no problem at all," he says.
But it all depends on the manager, and what they are prepared to give, he says. "We would hope that any manager has all the data available to manage the portfolio intelligently… after that, it is how far he is prepared to go and if his systems allow it," says Van Gent.
The biggest hurdle for the investor in respect of indirect real estate vehicles is achieving fair terms for entry into and exit out of the fund. It is vital that the manager apportions the property within the fund fairly between the participants. Van Gent says that unfortunately a lot of vehicles lack these terms of fairness.
"Real estate is something whose value you don't know until you sell it," he points out. Funds deal with this problem in a number of ways; some have a lock-in phase while others use expert valuers to estimate the value of the assets at any one time. In the latter case, entry and exit are based on these valuations, but this leaves a lot of room for discussion, says Van Gent.
When the method is ‘exit in kind', which properties should be included is a matter for debate. "This is the biggest headache we have," he says.
Caisse de pensions de la Republique et Canton du Jura
Indirect real estate funds are certainly very transparent compared to the properties they are invested in, says Christian Affolter, director of the Caisse de pensions de la République et Canton du Jura in Switzerland. "But, costs can still be a problem, which are similar for all the real estate funds," he says.
He says that the fund is aiming for 20% real estate assets. It has total assets of around €552m. All of the property investments are based in Switzerland, and most of them are in the Jura region. While 93% of the Jura pension fund's real estate investments are direct, 7% are held via indirect vehicles.
There are several reasons why pension fund needs its real estate investments to be transparent: they need to have information about the properties that the indirect vehicle holds within its portfolio. Specifically, the data it requires includes the nature of the investment itself, where it is geographically, and the year it was built.
Also, the pension fund needs to know about the liquidity of the vehicle in which it is investing, details about its precise cost , and the difference between the net asset value of the vehicle and the actual value of the underlying properties it holds.
Is transparency a good reason for investing directly? Perhaps, but the Jura pension fund had other reasons for taking the direct route. "For us, the direct investments were carried out mainly to encourage construction in our area in the 1980s and 1990s," says Affolter. "Currently, our projects have decreased appreciably because construction is too expensive and the rents are too low."
This is why the fund has sought more robust markets such as the Basle region, Zurich, Bern or Geneva, but because these areas are further away, the fund opted to invest indirectly.
BT Pension Scheme/Hermes Pension Management
Knowing exactly what is going on within an investment vehicle is very important for Hermes Real Estate. Alasdair Evans is director of corporate real estate finance at Hermes Pensions Management, which is owned by, and manages, the BT Pension Scheme.
Evans says Hermes Real Estate aims to apply the highest standards of corporate governance in investment for the BT Pension Scheme and all of its other clients.
"When investing in unlisted real estate funds, Hermes Real Estate will assess a large number of characteristics, including liquidity, alignment of interests and control," he says. "We also need transparency of information in order to make these judgements, principally through presentations and information memoranda at fund launch, and fund reports for mature funds."
Evans notes that the investment team would always expect to hold several meetings with management and dig much deeper to really understand the way a fund works. If they did not get enough information on a new fund, or if that information was not good enough, then they would not invest.
"On our existing holdings, we are often challenging managers to deliver information beyond that found in their normal quarterly reports," he says. "For example, the level of reporting we require in respect of debt implicit within a fund - such as key terms, pricing, mark to market of any hedging instruments - is more detailed than managers are used to providing."
He points out that the main information Hermes would look for would be historic and projected geared and ungeared returns, with some comparison to the market - ideally a relevant IPD based benchmark. "And we will also want to understand the investment strategy". Evans says that in the case of a new fund, the team would always try to challenge the key terms, and where it is appropriate, they expect influence how the shape of a fund's strategy and governance.
"Other investors will benefit from this, either formally where we lead a syndicate of investors - such as with the Paradise Street Liverpool retail development, managed by Grosvenor - or informally," he says.
He points out that managers are generally receptive to change when clear reasons have been given. In particular, Evans says the investment team tries to get terms giving the best potential sale value of a stake in an indirect vehicle, and this makes the vehicle more attractive to the next investor, in turn boosting the liquidity and overall standing of a fund.