For fund managers, money talks - but small pension fund investors don't like it. Shayla Walmsley looks at why smaller pension funds often feel disempowered when investing in property.

That smaller pension schemes investing in property funds often feel disempowered compared with their larger counterparts is the upshot of a recent PwC report commissioned by the Association of Real Estate Funds (AREF), which found an appetite among smaller institutions for independent investor representation and oversight of fund managers.

The idea that there could emerge conflicts of interest between larger and smaller institutional investors in the same real estate fund should come as no surprise. What is more surprising is how little assumption there is that investors should be treated equally.

"Having a large pension-scheme investor makes it easier to raise capital so they'll be able to negotiate more interesting concessions," said Nick Duff, principal at Aon Hewitt. "But aggregated investors can benefit from the same concessions. Often fund managers will treat pension funds investing £Xm in a fund as a single investor."

He pointed out that consultants would effectively act as an independent representative of a fund's multiple smaller investors. "We've had a lot of success in approaching managers where they might be issues," he said. "You'll have more influence if you're representing a meaningful percentage of the capital in the fund than you will if you're an isolated investor."

My consultant's bigger that yours
Whether the UK pension funds' reliance on intermediation is necessarily a good thing is a separate issue. The question here is whether it evens up in the relative weight of investors.  Even if consultants have only a few clients invest in a fund, said Duff, they drive manager appointments and do due diligence on funds. "If the fund manager won't listen to consultants who down the line will make recommendations to their clients, it will come back to bite them," he said.

The head of a large multi-manager business, speaking on condition of anonymity, told IP Real Estate that some large investors had adopted a new strategy. "They have deep pockets and go looking for funds, often ones they've invested in before, demanding concessions that would damage the fund and the other investors," he said. "You can be the classroom bully and beat up everyone, but the others won't want to play with you."

He added: "My objection is not to demanding investors - we're also a demanding investor - but to cases where investors want a deal for themselves at the expense of the fund. It certainly isn't always the case that a large or cornerstone investor will damage the fund, but you have to draw your own conclusions about whether their influence will be positive or negative."

In one case, an investor was effectively getting paid to put capital into a fund by demanding a capital ratio fee because there was a hole in the documentation that allowed them to do it. "You can't blame the investors," the manager said. "It's the fund manager's fault because they play along with it."

A fix - but not a quick one
From a governance perspective, the problems identified by the PwC report are fixable. A number of potential options exist for independent representation, including independent memberships of fund manager boards, investment committees and investment committees.

But short of empowering consultants to act on their behalf, it seems there is little smaller pension funds can do about the asymmetry of influence. "It is these sorts of concerns that have driven larger investors to move out of the fund environment," said PwC real estate funds partner John Forbes, who conducted the interviews for the report. "If you're a smaller investor, you don't have that option. A pension fund with £10m to invest doesn't have the option of a segregated account, for example."

Forbes pointed, in addition, to an asymmetry of information that allows larger investors to exert disproportionate influence. "It's more difficult to smaller investors to see what's happening," he said.

On the other hand, that smaller investors feel less communicated with is the result of managers being more attentive to investors overall. Fund managers' improved informal communication with large investors has inadvertently excluded smaller ones.

In theory, independent representatives could bring this kind of asymmetry to light. But the multi-manager drew a comparison with regulated funds, where "the regulators don't know what's going on until someone tells them". He adds: "With all the controls - the regulators, the auditors and so on - you'd think there were many safeguards. But they don't necessarily work."

Although Duff said he would support independent oversight of funds, he would only do so if the independent overseer had the skills and track record to carry out the role properly. "What we don't want is yes-men," he said. 

Whether an individual's record will be enough to resolve an underlying tension between those with capital and clout and those with less of both is another question.