Building Better Returns

Like most property investors, the California Public Employees’ Retirement System (CalPERS) saw its real estate portfolio hit hard during the financial crisis. In 2011, the pension fund introduced a new strategic plan aimed at improving and de-risking its exposure to property. Despite the new plan, the fund’s real estate allocation continues to underperform compared to the benchmark, delivering only 2.84 percent in 2013. CalPERS benchmarks its real estate performance against the NCREIF Fund Index Open-End Diversified Core Returns (NCREIF-ODCE), with the goal of exceeding it—net of fees—according to its March 2014 benchmarking policy statement. In 2013, the benchmark posted a total return of 7.07 percent. “The real assets performance still carries the effects of the housing crisis and economic meltdown,” a CalPERS spokesman told PrivcapRE in an email. “A new strategic plan was put in place for the asset class several years ago and we continue to operate according to that plan.” CalPERS uses real estate as both an inflation hedge and a counterbalance to the heavy equities weighting in its portfolio, according to fund documents. Property’s role is to provide an investment with a low correlation to equities, to generate stable cash yields, and to give the fund an inflation hedge. “As the equity allocation in the overall CalPERS investment portfolio is high and the risk contribution from equities is higher, the role of real estate in the overall CalPERS investment portfolio will be…moderately levered, low risk, and low correlation with equities,” according to the pension fund’s 2013 investment policy. “To fulfill this role, real estate will have ownership risk in real properties with stable cash yields. The major driver will be income, of which the majority will be cash yield. Real estate is also a partial inflation hedge.” As of December 2013, CalPERS’ real estate allocation was 9 percent of the total fund, with a target range between 7 percent and 13 percent. Real estate comprises 87 percent of its $27.8B real-assets program. Its program has an emphasis on investing with market-leading real estate investment managers and a focus on the United States. The fund uses commingled funds, separate accounts, manager accounts, real estate operating companies, and downstream joint ventures, with a preference for separate accounts, CalPERS’ investment policy states. “The focus of the portfolio should be in large strategic relationships. Investments may be made in public or private debt or equity positions or other related real estate investments.” CalPERS has a focus on developed markets, targeting a 75 percent to 100 percent allocation, with 85 percent to 100 percent of that allocation to be in the U.S. Its target allocation for investment outside of the U.S. is zero to 25 percent, while emerging markets has a zero-to-25-percent allocation and frontier markets a zero-to-5-percent allocation.

SURS

The State University Retirement System of Illinois (SURS) is building its exposure to real estate assets. The fund has more than $1B in real estate investments, comprising about 6.5 percent of its total portfolio, and aims to hit 10 percent exposure by the end of the 2016 financial year, according to its strategic plan. The goal is to have 4 percent of the total assets invested in REITs and 6 percent in private real estate. The objective of SURS’ real estate allocation is diversification and income, according to its 2013 strategic plan. Maintaining some liquidity is a priority for the fund, so a 40 percent allocation is made to property securities, and a 60 percent allocation is made to private real estate. The fund is targeting a portfolio of 80 percent core assets and 20 percent non-core assets. It invests in open- and closed-ended commingled funds for private real estate, and in separate accounts and commingled index funds for public securities. In 2013, the fund approved $400M in commitments to core and non-core private real estate managers. The fund is underweight on property compared to its target allocation and this year is looking for non-core real estate managers to help meet its target. The fund benchmarks its direct real estate investment portfolio to the NCREIF-ODCE. Its U.S. REIT portfolio is benchmarked to the Dow Jones U.S. Select Real Estate Securities Index and its global REITs to the FTSE EPRA/NAREIT Developed Index. The fund’s direct real estate portfolio slightly underperformed the benchmark in the 12 months leading up to March 31, 2014, delivering a 12.1 percent return compared to the benchmark return of 12.9 percent. However, its REIT allocation outperformed the benchmark’s 2.5 percent return, delivering a 3.1 percent return. In the past five years, SURS’ direct portfolio has outperformed the benchmark with a 4.7 percent return compared to the benchmark’s 2.8 percent. Its REIT portfolio underperformed, delivering a 25.8 percent return compared to the benchmark’s 26.1 percent.

SBAF

The Florida State Board of Administration’s (SBAF) real estate investments have consistently outperformed in the past decade, so there is little wonder why this year its board of trustees committed to raising its real estate allocation from 7 percent to 10 percent by the end of 2018. This represents an additional $4B in capital, according to a report from advisers The Townsend Group, who were first engaged to aid the pension fund in 2004. The pension, which now has a $10.2B real estate portfolio and manages more than 30 funds, started investing in the asset class in 1983, according to a March presentation given by SBAF senior investment officer Steven Spook. He said the role of real estate investment was to diversify the fund’s asset base as a hedge against inflation and to provide competitive returns throughout market cycles. Its real estate portfolio comprises 72.5 percent core, 9.7 percent value-added, 7.4 percent opportunistic, and 10.5 percent property securities. The portfolio is almost evenly split between principal investments (SBAF staff retain approval rights on acquisitions, disposals, and financing) and externally managed investments (where the manager has been given discretion to make decisions). It is anchored by core private market investment through direct-owned assets and pooled funds. SBAF’s preference is to invest through direct-owned separate accounts, which Spook says in his presentation delivered “superior real estate staff control and lower fee structures.” Pooled funds were used for “diversification, specialized strategies, and non-core investments,” he says. SBAF has a goal of a 90 percent weighting to physical property and a 10 percent weighting to property securities. Until June, SBAF aimed to outperform the five-year rolling average of a blended benchmark, which includes the NCREIF-ODCE, net of fees (90 percent weighting), and the EPRA/NAREIT Global index (10 percent weighting). However, at its June meeting, the pension’s investment advisory committee approved a change to the benchmark. The core part of the portfolio will be benchmarked to NCREIF ODCE (net of fees), weighted at 76.5 percent, the non-core portion benchmarked to an average of the NCREIF-ODCE (net of fees), plus a 150 basis point premium, weighted at 13.5 per cent, and the FTSE EPRA/NAREIT Developed Index, weighted at 10 per cent. A spokesman for the pension says the change would better reflect the expected risk/return profile of non-core assets. Based on the old benchmark, to the end of 2013 the real estate portfolio’s total net return exceeded the five-year rolling benchmark by 250 bps. It has underperformed the benchmark for only one month during that period (in September 2014 it underperformed by 50 bps), according to the Townsend report. “The portfolio’s net return has consistently exceeded the benchmark since Q3 2002. As of Q3 2013, the portfolio exceeded the benchmark by 180 bps. This outperformance has been driven by SBAF’s core investments, which outperformed the ODCE by 420 bps over the same five-year period,” according to the Townsend report, which notes the strength of two of the biggest investments, the Heitman Core I.M.A. and the L&B I.M.A. “These two accounts represent nearly $3B of market value as of Sept. 30, 2013, and have outperformed the ODCE index by 650 bps and 510 bps, respectively, over the five-year period,” according to the report. An SBAF spokesman says the strength of the performance could be attributed to the pension’s “structure and strategy [which] emphasize direct investment and low leverage. Together, these attributes create long-term advantages because of lower fees and far less vulnerability of becoming a forced seller in down markets,” he says. During 2013, SBAF made about $350M of commitments to three non-core closed-ended funds targeting investments in the U.S., Europe, and Asia. A further $50M was committed to a student housing joint venture. In its principal property business, SBAF made about $218M of commitments to three investments: a retail aggregation strategy located in Boston, a multifamily property in Irvine, Calif., and a Denver industrial asset. ■