Pension fund posses are a familiar idea for those seeking bigger, better deals in unfamiliar markets. Now the consortia are getting more adventurous, as Shayla Walmsley reports
The announcement in February that the $81.3bn (€56bn) New Jersey Pension Fund will seek institutional partners in a bid to gain better infrastructure deal terms may turn out to have marked the emergence of a new model for investment.
In the past, joint ventures have facilitated geographical diversification into complex emerging markets by marrying local industry expertise with overseas - often pension fund - capital. Now there is talk of broader deals with broader targets - of a new investment model that could include sovereign wealth funds, as well as other pension funds.
So how will the new model work - and which pension funds are most likely to opt for it? Unsurprisingly, the most aggressive joint venturers to date - at least in direct investment deals - have been in the US. "Nothing is off the table," says Susan Burrows-Farber, chief administrative officer of the New Jersey scheme.
The outrider is still talking the talk. Burrows-Farber says the scheme will not begin to formalise its search for partners until after September, when it has drafted the scheme's real estate investment plan for fiscal year 2008-09. In the meantime, the most complex joint ventures - at least in Europe - have been indirect. In most cases, it has been fund managers who mooted them. Even where the impetus has come from the pension funds themselves, fund managers have been indispensable in structuring the vehicle.
"The key to a successful joint venture is to find the right manager," says Michael Nielsen, head of investment at ATP Ejendomme, the DKK349bn (€47bn) pension fund‘s real estate subsidiary. "Even institutional investors with good ideas won't succeed without one because they wouldn't have the in-house skills or confidence to undertake these deals by themselves."
Fund manager and pension fund co-investment - the industry buzzword du jour - applies to several separate phenomena, from multi-partner joint ventures to pooled funds. At its broadest, it applies to investment managers contributing their own capital alongside that of investors. Of the partnership models, this one has gained most ground in recent years.
Will Rowson, chief investment officer at ING Real Estate, suggests that ‘aligned' investment has become a default requirement for institutional investors. "Almost every investor expects some kind of alignment now," he says. Duran cites cost, notably the reduced fee structures offered with most co-investment opportunities. Pension funds may be stumping up the capital, but they're also saving on continued outgoings.
If the idea that managers should demonstrate faith in their own products is uncontroversial, how they should go about it is slightly more complicated. Rowson cites the Morgan Stanley model, derived from private equity and opportunistic funds, which comprises alignment at director and fund manager level. Investment staff pool a percentage of their bonuses earmarked for investment in the bank's funds.
A model currently in development at ING Real Estate tweaks this one, aligning fund managers, board-level managers and portfolio managers with their funds, but with a percentage of each year's bonus pooled and paid three years later. One benefit, Rowson says, is that it will enable fund managers to hold on to good people longer - another requirement of pension fund investors. Management is all.
If fund manager alignment is well established, European pension funds have in the meantime accumulated indirect experience of co-investment. Take the €700m co-investment vehicle set up last year by ABP, ATP and German property firm Patrizia. In most cases, the industry partner has specific expertise; in this case, Patrizia had expertise - but in a different area.
According to Patrizia spokesman Andreas Menke, the vehicle's exclusively commercial focus avoids a conflict of interest with Patrizia's largely residential portfolio. At the same time, it expands Patrizia's expertise in another segment. The vehicle will be fully invested by early 2009.
"I'm not sure whether we'd call what we've done with ABP and Patrizia a joint venture or a club fund," says ATP's Nielsen. "For us, it's another type of indirect investment." ABP and ATP each contributed €60m and pledged additional capital of €40m each to the joint venture when it launched; Patrizia contributed €8m.
The market will likely stall nascent partnerships. Nielsen says there are "no hot projects" in Denmark - that ATP is taking a wait-and-see attitude on pricing.
But you could see multi-partner ventures simply as outgrowths of the traditional two-way model. Compare the Patrizia threesome with a 50:50 joint venture deal signed in March by the £13.8bn (€19bn) BP Pension Fund and Great Portland Estates, the property company. The partners launched the deal with a single development, a £27.5m prime London site with planning permission for a mixed-use block, with the option of adding further assets.
Placing the joint venture within the context of an allocation increase to real estate, a spokesman says it would allow the BP scheme to scale up its exposure to development assets.
Access to larger-scale investments had earlier been the impetus for the Danish Real Estate Club, a network of five pension funds set up for the purposes of collective bargaining in 2004. The five - PKA, PenSam, Kommunernes (SamPension), PFA Invest International and Finanssektorens Pensionskasse (FSP) - saw the club as a risk-minimising means of increasing their exposure to overseas real estate, with collective clout offering access to bigger, better deals.
The primary driver for real estate joint venturing is still overseas investment. "Part of our strategy is to look at more of these partnerships, for instance in markets where we don't have sufficient exposure," says Nielsen. "The key is to find the best managers in these markets to do it with us. It's quite unique to find a good fund manager."
As rationales go, accumulated weight comes a close second. Ubbe Strihagen, international director at Aberdeen Property Investors, points out that the difference between investing in real estate and investing in other asset classes is that each property investment is "unique and quite large".
"It is a great advantage to pool your investments to get increased diversification and access to the expertise in deal sourcing, transactions and asset management," he says.
"Historically larger institutions have conducted much of this themselves in their domestic market. But nowadays when most investors seeks an international diversification, their internal skills and reach is not sufficient."
In other cases, regulation has driven the decision to bring in an additional pension fund partner. In ATP's case, for instance, accounting rules dictate that Danish pension funds are allowed only to participate in joint ventures with ownership under 50%.
Once a pension fund has decided on co-investment, the question for Strihagen is when to offer what - when might a multi-partner agreement work, in which circumstances and for what purposes. In some cases, they end up with a bespoke fund invested by a number of pension funds: that was the case, for instance, with a €200m fund set up for Ilmarinen, the Finnish €21.6bn multi-employer pension scheme, Dutch pension fund ABP and Denmark's €49.6bn ATP fund.
"We always have a dialogue with our clients on what a suitable total portfolio would look like," he says. "Primarily it depends on the size and resources of the investor. Hardly any investors have the size to build up their own direct portfolio internationally. So the question is if they have enough capital and expertise to build up their own international portfolio of funds or should they add some investment into fund of funds structures to get a better diversification."
Indirect co-investment usually offers pension funds more control than the usual indirect investment vehicles - but perhaps in some cases not as much as pension funds would like. In the three-way deal with ABP and ATP, Patrizia, with a 6.25% in the co-investment, is responsible for all acquisitions and management of assets.
Broadly, says Strihagen, "if the investors have a say in the operations of the fund, one needs to limit the number of investors dramatically. The management and decision making gets very complicated unless the investors has given a clear discretionary mandate to the fund manager. The fund manager should manage the fund and all the decisions concerning it."
How discretionary that mandate turns out to be depends on the deal struck at the beginning. "One advantage is that you have greater influence over the terms of the investment," says Nielsen. "You sit down in a small group and set out the terms, rather than a fund manager saying take it or leave it."
The last thing a pension scheme partner wants to be doing is arguing over the acquisition of this or that asset. "It's important that you have a clear, defined investment strategy for the fund so that you don't end up having to discuss whether to include this or that asset. You need to decide in advance, for instance, which decisions are to be taken by the manager. There's usually a board to deal with that kind of decision. If there are only two or three partners, they'll all have to agree. It should really be unanimous."
CalSTRs spokesman Ricardo Duran claims co-investment allows the scheme to assess risks and returns for a specific asset, and that this "gives CalSTRS a greater degree of control than in the standard investor-manager fund situation, where we're investing in a strategy rather than specific assets".
The potential for pension fund control - over direction or assets - varies. Midway between controlling fund managers and pension schemes aiming to wrest control from them lies the bespoke property pooling structure set up for Folksam by Aberdeen last October. The Luxembourg-registered AIPP Folksam Global, designed for the pension funds of Folksam subsidiaries in different markets, gave the group "influence, though not full discretion" over investment decisions. In an interview with IPE Real Estate at the time, Lars Graneld, then head of separate accounts at Aberdeen, said: "We'll keep them well-informed. They could, in theory, say no to an investment because they'll have the final say - a veto, if you want to put it like that - but it's unlikely.
"For the client, it's an attractive proposition because they have some control but we do the work."
Perhaps one of the reasons why the control issue remains relatively nebulous - in practice, if not in contract - is because partners in co-investment agreements tend to know each other well. In fact, direct and more complex indirect agreements often emerge from commingled fund arrangements.
"Most of our co-investments in real estate (and to some degree in private equity) are done with an existing partner - with which we may have commitments to an existing fund," says Ricardo Duran, a spokesman for CalSTRs. "CaSTRS looks at each co-investment prospect with the same rigorous due diligence as we do with any potential investment.
"As for the number of partners in a deal, the greater the number of partners the more complex the deal. There is a great deal more complexity in the relationship management and in the alignment of interests as the numbers increase."
That is true even if you start out, as Nielsen recommends, with like-minded partners on issues of investments strategy, corporate governance, and risk and return. "In principle you could do it with many investors - it doesn't have to be with a special, small set - but it's very much driven by personal contacts and personal relationships between investors , so we prefer only to deal with two or three other investors," he says.
Given proof of concept offered by the Danish investment club, and assuming that New Jersey's soon-to-launch partner-gathering strategy pays off, it is likely that European pension funds in future won't necessarily stick to partners they know.
The New Jersey version, announcing in advance that you are looking for partners, is relatively rare. But the drivers are common. Above all, complex co-investment partnerships reflect a ‘classic' focus on pension fund concerns: diversification and risk management. Joint ventures, clubs and co-investment are a sparkly new means to the same old end.