A Call to Break the Fund Mold

Drew Ierardi, senior portfolio manager of private markets at Exelon, urges GPs to think more creatively about fund structures and investment periods.

GPs should think more creatively about the structure of real estate commingled funds and not be afraid to “break the mold” of the private equity model, says Exelon senior portfolio manager Drew Ierardi.

As the $15B corporate pension plan juggles the challenges of redeploying early fund distributions back into strengthening real estate markets, Ierardi calls on investment managers to be innovative and candid about the best way to invest in the asset class today.

“Traditional closed-ended vehicles are ripe for innovation,” he says. “I’m open to seeing more new types of fund structures that attempt to break the mold in whatever direction that is.”

One of the key challenges Ierardi and Exelon face is earlier-than-expected distributions back from value-added and opportunistic funds that have sold assets following strong capital appreciation. By using real estate as a pure total return play rather than needing a component for current income, the early distributions have generated great IRRs but impacted equity multiple expectations.

For Ierardi, the early distributions have also left him facing the risk of investing capital into a rising market that could peak during a new fund’s investment period. “Because we are a fund investor, if we sign fund documents today that [capital commitment] isn’t going to be invested for another 18 months so you’re not buying at 2015 prices, you’re buying at 2016 and 2017 prices.

“In a way, it would be easier if we thought the world was going to fall off a cliff in two years, because we’d be able to react in specific ways in anticipation of that. But given the potential distribution of outcomes from this point forward, how can anyone be confident in the state of the market two years out?” he asks.

Conceding that investing in real estate is harder for investors today, Ierardi explains that there is much less clarity over the direction of the property markets—and the pricing of assets—than at any point in the wake of the crisis. “It makes us hesitate to commit capital,” he says.

As a result, Ierardi wants to see managers think differently in terms of fund structures in an effort to help investors “embed optionality” in their own portfolios.

While there is no “silver bullet,” Ierardi suggests there is a “place in the universe” for longer-life vehicles in the value-added and opportunistic world, where managers could afford to be “a little bit candid and willing to say that maybe the best decision we can make right now isn’t to reinvest the gains [in a new fund] but to hold those assets longer.”

The pension is also trying to give itself more options by introducing a tiered commitment for some of its real estate re-ups, whereby the plan commits to a follow-on fund at the same level as the prior vehicle but reserves the option at a later stage in the fundraising process to commit a further 20 to 25 percent capital.

Exelon has 6 percent of its total fund allocated to real estate, investing in REITs, core, value-added, and opportunistic strategies. However, owing to a separate $5B liability hedging strategy, Exelon can focus its real estate investments purely on generating returns and doesn’t need to invest if the opportunities aren’t present in the market.

“The way the pension is structured allows us a lot of flexibility to pick investments based on where we are at any point in time, what we are seeing, and what we think makes most sense on a risk-adjusted basis,” says Ierardi.

That flexibility also applies to the need for diversification within the real estate portfolio. Taking a whole-plan view of diversification—rather than trying to achieve diversification within the real estate portfolio alone—it means Exelon doesn’t have to “force a fit” for any particular real estate strategy.

“It takes a lot of pressure off us and means I don’t have to call the bottom in a market like Brazil, for example, because we’re already positioned to participate in that story through other asset classes,” says Ierardi. “We are ultimately trying to use real estate to build a diversified portfolio, not just trying to build a diversified real estate portfolio. We have that and it’s helpful, but flexibility over diversification allows a lot of room to reach more unusual answers.”