Going European, going private
Denmark’s e37bn ATP labour market pension scheme holds a rather unique position amongst European pension funds – everyone in Denmark is a member due to its role as an obligatory supplement to the state pension.
The sixth largest pension scheme in Europe, ATP has investment spread accordingly across the various asset classes on a broad geographical basis.
And as Michael Nielsen, director of ATP Real Estate in Copenhagen, explains, the fund is having to look both abroad as well as domestically in order to satisfy desired allocations in real estate. In addition, the fund has changed tack from a direct to an indirect investment approach to enable it to manage the move into unfamiliar real estate terrain.
From the mid-1970s, says Nielsen, ATP invested solely in direct property in Denmark.
Today the fund has a domestic portfolio of approximately e1.4bn, spread over all property types, although for political reasons the scheme does not invest in domestic residential buildings.
“We’ve now created a more focused strategy in Denmark in that we are only investing in the office and retail sectors – with the focus on Copenhagen as the most liquid area of the Danish market.”
These buildings are all managed in-house via a 40-strong department, making ATP one of the largest property players in the Danish market: “In the last year or so the Danish market hasn’t been that attractive – but that goes for the whole of Europe.
“It’s still our intention though to be a large player on the Danish market focused on office and retail.”
The fund’s Danish holdings, Nielsen notes, are run as a ‘core’ strategy in that they take very little development risk and are not geared.
However, approximately three years ago ATP carried out an ALM study where it decided to increase exposure to real estate from current levels of 3.5% to 5% in both domestic and international property - a target to be reached by the end of 2005.
The international diversification prompted the fund to rethink how it operated in real estate: “It took a year to decide how to do this, but the first conclusion was that it couldn’t take place in Denmark, because the market was simply too small.”
The fund then looked outside the domestic market and came to the conclusion that it should not go direct but rather indirect for overseas exposure.
“We could not repeat what we do in Denmark and make direct investments all over Europe because local presence and local management are all extremely important skills,” explains Nielsen.
The fund then created an investment strategy for what it calls its ‘international programme’. This has a focus on non-listed real estate funds, due mainly to tax reasons: “If we go into the listed market we will have a double taxation problem,” says Nielsen.
“The focus will be solely on closed-end, tax efficient structures.”
Next, the fund set about defining its investment restrictions in terms of sectors, geography and fund styles.
This produced an overall target for ATP that by the end of 2005 it should have invested approximately e600m spread over 15-20 funds all over Europe.
“We will stay in Europe for the first programme. If you take the countries in our strategy we have a few main targets, which are the UK, France and Germany.
“We have changed our attitude a little bit about Germany and we could focus here towards the end of our programme.”
Regarding sectors, Nielsen says that office and retail will cover 80-90% of the total exposure. “We have room for logistics and a little bit of residential as well as some development, but due to the poor condition of the office markets in the last couple of years what we have done up until now has focused on logistics and retail.
“We still hope that the office markets will turn around and recover. All over Europe I think we have seen the first positive signs from a number of cities, but we still have London and a number of the German cities where we are waiting for this.”
The decision to move outside the Danish property market, says Nielsen, was also supported by the introduction of a clear investment process for property within the fund.
He explains: “We’ve built up a process we go through every time before we commit to a new investment. Firstly, we maintain a database and we pick out a number of funds that fit the criteria we are going for. Then we make a long list and carry out data screening of al the funds on the list. We then produce a shortlist, interview the candidates and then pick out one or two funds and run them through what we call our legal, tax and property due diligence process.”
However, Nielsen says the fund’s move into indirect funds has created a number of supplementary issues that needed to be worked out.
“This market has characteristics that are 50% real estate and 50% private equity, meaning that you need real estate knowledge but you also have to deal with a number of private equity issues. This means that we have had a lot of help and brought in experience from ATP’s private equity department – which is also one of the largest in Europe.
“It’s been very challenging and we now have a team of advisors outside of ATP and we also have a little team of five people internally to deal with this.”
ATP worked with Hewitt Bacon & Woodrow on strategy advice, while ING Real Estate acted as property advisers with LaSalle Investment managers also contributing in an advisory function.
Nabarro Nathanson in London acts as the fund’s legal adviser and KPMG deals with the fund’s tax issues.
The first tranche of European real estate mandates (seven so far representing e185m in assets) within the programme were awarded from a 50 strong shortlist investigation (see table).
The eighth fund commitment, which will be announced shortly, will be a pure retail fund, Nielsen adds.
This leaves ATP with e365m still to invest in property before the programme ends in 2005, with Nielsen expecting to invest in another seven to 10 funds in total.
The fact that the fund has already made commitments to high-octane real estate opportunity funds, was also a first for the scheme: “I must say this was a different approach. A large part of our exposure according to our strategy has to be in core funds, but we have a portion allocated to opportunistic areas.
“They were a little more complicated in terms and conditions than the more core funds, but we have a good due diligence process and also good back up from our advisors and we are ready to run with this approach.”
Nonetheless, Nielsen has some advice to offer US fund managers trawling for European institutional clients: “When the US fund managers invite European institutions to join their funds I think they also need to adjust their terms and conditions to a more European style!”
Benchmarking these investments is also another quandary for the fund, due to the lack of any such measures on the market for private property funds: “We don’t have a benchmark yet, but another part of our move into the European real estate market has been that we are very much part of the set up with INREV.
“ATP was one of the founding members two years ago and I have been a member of the executive board since then. One of the goals of INREV is to create a benchmark in collaboration with IPD (Investment Property Databank) and OPC (Oxford Property Consultants).
“We hope that in a years time or so we will have the first benchmark through INREV.
“The benchmark issues doesn’t pose us problems in the short term, but in the longer term it could create some problems. In the beginning when we entered this market though we knew there were no benchmarks, but from the private equity side we know a little bit what returns will come from investments like this.”
Nielsen says ATP has also been involved in the building of INREV’s web-based database of approximately 300 private fund vehicles, which is where he says ATP expects to source its manager long lists in the future.
Another area where Nielsen says the aims of INREV tie in with the fund’s aims is on transparency and standardisation of issues such as fees, contracts and reporting to investors.
“Until now with the mandates we have awarded we’ve had seven different examples of fees, reporting and contracts, so I really hope that through INREV we can get more standardisation in these areas. “I think improvements here will make this market more attractive for smaller investors also.”
A further crucial issue, says the ATP chief, is corporate governance.
“A few years ago we saw all the power placed with the fund managers, but now we will not make any investments where we do not see a fair balance between the investors and the managers. We don’t want to take responsibilities for the buildings or investments, but we do want all the important decisions to be shared with the investors. That means the whole fee structure.”
To this end, one of the big discussions in the market at present is whether investors should pay a fee for non-invested capital in real estate commitments.
Says Nielsen: “We don’t accept that in general, although there could be examples where we need to accept that because there is a lot of work for the fund managers to find and develop projects. But fees for this are on their way out of the market.”
Similarly, ATP advocates more alignment of interest in investments and is trying to incorporate ideas from the private equity world into real estate: “ Whether it’s an opportunistic or core fund, today if we are looking at opportunistic funds we would demand a high level of alignment. That includes investment from fund managers, investment from individuals in the team and that the carry/preferred return will go personally to the key members of the team. In addition we will always have a clause that if a key member of the personnel at the manager leaves we will have some kind of mechanism to address this or remove our commitment completely.”
Gearing or ‘leverage’ is another factor that pension funds have to look at when investing in private funds. ATP’s stance is that at the portfolio level it can only have a 65% gearing level above the original investment. This means though that the fund can invest in an opportunistic fund with 75% gearing and balance it up with a core fund at 50% gearing, leaving a weighted average of 65%.
“I can’t explain why we said 65%, but it’s a question of limiting risk because we know there is a risk on your equity with gearing,” comments Nielsen.
Beyond the continued allocation of assets in the original European indirect programme, Nielsen points out that some of the funds where the fund has invested will start winding up in 3-4 years time, meaning that ATP should reinvest its money.
“Nothing has been decided yet, but it’s my hope that we will be asked to bring further diversification into the programme and start looking at US, Asia or global funds.
“This could be through a REITs structure in the US or through other entities. ATP is very active all over the world already in private equity, listed shares and funds, so there’s no reason why we shouldn’t do this. But we’ll start outside our front door first.”