Large managers often tout their size as a selling point. Marketing puff or serious stuff? Adrienne Margolis reports
Over the past few years there has been a change in pensions funds' attitudes to real estate investments. There is now much more willingness - in response to an increasingly powerful rationale - to consider this asset class in a global context.
Many institutions are still deciding what route to take. The scene is changing so quickly that different experts have different views on whether managers necessarily need to be big to deliver performance, against a backdrop of increasing global diversification.
Some consultants believe that it is hard to be credible as a global manager if you do not have scale. "To be fully global you need to be investing in Europe, North America and Asia," suggests Greg Wright of Mercer. "Real estate is still predominantly a local business, and if you try and invest in a country without the knowledge, you are at a disadvantage. In the early 1990s pension funds discovered this when they attempted to invest globally. They did not know the legal and tax regimes well enough and found that the locals were getting the juiciest deals. So we would like to see organisations having their own people on the ground, or employing good locals."
Mark Meiklejohn, investment director of Standard Life, is not convinced that a local presence is the most important issue for larger institutional investors seeking to go global. The size of asset management operations is important. "Scale is crucial because of lack of transparency," he says. "We do not think that you need a local presence in each market but you do need personnel with a depth of expertise in tax and legal issues. This is an important resource."
"A key issue for me is that everyone talks more about non-domestic funds for real estate, and we would not have been having this conversation two years ago," he adds. "It is a very new concept."
But there is a stumbling block, because it is difficult to find suitable investments overseas. "There are huge tax impediments to overseas investment. There is also the complexity of cycles in different regions. Take Asia, for example, where there are five or six different economic cycles and it is difficult to have a view on when to invest. This makes real estate more difficult than other asset classes," Meiklejohn says.
"Local knowledge is very important," Steven Grahame of Watson Wyatt says, but stresses that there are fundamental questions that investors need to ask, before the size of the asset manager comes into play. "The questions are: What is the local team doing that is different? What is their management style or underlying risk? Do they develop property? Are they trying to provide a diversified portfolio of assets or create value? Even then, you only proceed if there is an investment case which stacks up post fees and all costs for making an allocation." The investment case involves establishing what opportunities the managers recognise, and trying to get good allocations to the best ideas, Grahame adds.
"Some managers say that because they can pick countries and markets they can pick local managers or joint venture partners," he says. "Others recognise that diversification requires regional core funds or global funds. However, at present there are no mature global funds so we guide clients to look for the best local managers and diversify management selection risk - the multi-manager approach using an investment manager."
Multi-manager can work for smaller as well as larger asset management groups, and Grahame believes there is a strong case for multi-management, because it can combine investing globally with investing in local expertise.
Some consultants insist that for a global reach, the larger the manager, the better. "To work globally you need to have a presence in all the countries in which you invest," Edward Barker of Zanders Real Estate Investment says. "A small fund selling investments globally has a problem. They can circumvent this if they outsource work to local experts, but would this be a selling point for the asset manager? For these reasons, I believe for global investment a larger manager would be preferable."
For multi-management of funds-of-funds, Barker believes that you need larger asset managers because of their knowledge of markets. It is crucial that the managers know which funds are performing. "Smaller funds should focus on asset management selection," he suggests. "If pension funds are investing in smaller asset managers, it should be because they have a niche."
Meikeljohn agrees that there is always a place for specialist and niche players, particularly in less transparent markets. But he also believes that to make a real impact, size matters. "We think the central function outweighs the importance of a local presence, although you may need that too," he says. "It is extremely important to have scalabiltity."
Some pension funds use other criteria for investing globally, that are more important to them than the size of asset manager. "We invest outside Denmark in Europe and the US, and only indirectly outside our own country," ATP Real Estate investment manager Arne Andreasen, explains. "We base the decision on which manager to use on their returns. In each country this can be different - we want managers who are experts in their own countries."
This can mean the manager in each country is a different size, and that some are multi-managers. "Again it will be because they are producing the best returns in a particular country. An advantage is that it helps us achieve manager diversification. It also means that we can benchmark managers against each other."
Larger pension funds can make a lot of the decisions on investing globally for themselves, so the size of asset manager may be less of an issue, Albert Yang, director of institutional business at Hendersons Global Investments, says. "Large companies have their own in-house management and they are getting more sophisticated. But the UK is behind countries like the Netherlands in the sophistication of pension fund investment in real estate," he adds.
The Netherlands is out in front on global real estate investment because of its very advanced pension fund system. "There is a large amount to be invested and a very small home market. That has meant that we have been forced to take money cross border," Patrick Kanters, manager, real estate for ABP, explains.
ABP has been investing globally in real estate since the late eighties. "In 1996, 95% of our assets were held in the Netherlands. We started to transfer into indirect investment and to put direct investment at arm's length, and our domestic assets now account for 15% of our portfolio." Kanters explains. "We set up a New York office to be closer to the US property market, and now have 15 people working there. At the beginning of this year we set up a Hong Kong office - we were already investing around 15% of our funds in the Asia Pacific region. The reason we have decided to set up an office there is to be closer to Asia's often more opaque markets and to further build our relationships."
ABP has the scale of operations to manage its real estate investment portfolio in-house. "Our size means that, internally, we can exchange things like best practice, due diligence and capital market insight, while aligning ourselves with the best managers across the globe," Kanters says. "We capitalise on the knowledge and skills of each individual fund team."
As long as you ensure that there is good governance and alignment of interest, it is a great way to diversify, he believes. ABP's portfolio includes investments in emerging countries in central Europe and Asia, including China and South Korea.
"Leaving aside the last half-year, over the last three years our returns have averaged 30%+. This has been helped by the performance of both listed and non-listed markets and the fact that we are already strongly diversified."
By contrast, German pension fund NAEV is outsourcing its real estate asset management and is actively considering the multi-management option for going global. "We have not invested globally up till now, and for us, size is crucial," Herman Aukamp of NAEV's property investment department says. "It can be a boutique-style manager as well as a big guy. It always depends on how it fits our investment strategy."
Aukamp believes that for NAEV, multi-management can work much better than standalone funds. But the first decision the pension fund needs to make is how much to invest globally. "We do not want to put amounts that are too small in to too many different entities," he says.
Although there are not many global funds available at the moment, Aukamp is optimistic that they will be coming on stream. "It is a matter of time as much as anything," he says.
If pension funds are taking the multi-management route to global investment in real estate, for now, their choice is likely to be limited to the larger players - CBRE, ING, Axa and Morgan Stanley, for example, which can offer wide geographical exposure.
Larger players are in a position to add value, Julian Schiller, head of indirect investment at Jones Lang La Salle, argues. "If you want to operate globally your asset managers need to be big enough to add value. This means that they need to be of a sufficient scale to operate in all continents, with local offices and on-the-ground presence."
Meiklejohn believes that when it comes to adding value, investors need to be aware of the costs of multi-management. "We have not operated that way, but provide the product for multi-managers," he says, adding: "We do wonder whether clients understand the cost implications of the fees."
Investors in funds of funds pay both a management fee and a fund fee. "We discuss this a lot," Aukamp says. "It is crucial - multi-management comes at a price. But we recognise that people have to be paid."
Invesco also creates multi-managed funds, and Andy Rofe, managing director of Invesco Real Estate admits that it is "a lucrative business". It is important to have economies of scale, Rofe notes, and funds of funds are popular because they avoid having to set up your own infrastructure. "They allow investors to dip their toes in the real estate market," he argues. "They provide instant diversification and huge choice. They have grown eight to 10 fold in the last seven years and the trend is still upwards."
"It is not easy for non real estate people to get their head around the fee structure," Jenny Buck, head of property multi-manager at Schroders, says. "They are investing in a fund, which invests in a fund. There are administrative costs for valuers, accountants and so on. These miscellaneous costs vary."
She believes that the industry is making inroads into improving transparency so that investors can compare funds more easily.
Meiklejohn is not convinced that outsourcing global real estate investment is right for Standard Life. "Multi-management has helped to keep the market afloat by making it more accessible. But devolved decision-making suits clients who do not have the time and resources to do their own research. The remit of pension funds includes finding the best manager. We do not hand this function over in other asset classes, so why do it for real estate?"
Kanters agrees. "We are in fact our own fund of funds, and have enough skills and mass to do it all ourselves. We have 30 people across the globe who select and manage funds. "We try to play a cornerstone role and be in the forefront of setting up funds," he adds.
Given that global investment in real estate is still in its early stages for most managers, "the key question is how they can adapt from a country or region led approach to a global approach," according to Wright.
But whatever the size of assets to be invested, he notes a certain impatience from pension funds which do want to hand over decision making on global real estate investing. "A lot of investors want to do this now. It means that they have to back a horse and see where it goes, even though the market is at an early stage."