Danish pension fund ATP signalled its international intent this year with its first real estate investments outside Europe. Michael Nielsen tells Richard Lowe about the challenges in managing a global indirect portfolio that is growing larger than its direct domestic counterpart
As the largest pension fund in Denmark, it is not surprising that Danish labour market supplementary fund ATP directly owns a sizeable chunk of its domestic real estate market. Michael Nielsen, head of real estate at the DKK419.7bn (€56.7bn) institution, explains that ATP has two primary ways of investing in its home market. "In Denmark we are a direct investor and we expect to continue to be a direct investor in our market," he says. "But we also have a few indirect initiatives, mainly development activities, which we as a pension fund don't want to be directly involved in ourselves."
The former is managed by ATP Ejendomme, a wholly owned subsidiary of ATP, which by the end of 2007 was overseeing 65 office and retail properties with a total market value of DKK11.7bn. However, the limited size of the Danish market, and the obvious need to diversify an ever-expanding volume of assets under management, prompted ATP to embark on a programme of investment in foreign real estate markets in 2002.
The international and indirect real estate portfolio is managed by ATP Real Estate and includes investments in more than 20 non-listed real estate funds. By the end of 2007, the market value of ATP Real Estate's investments was DKK7.5bn, less than that of the direct portfolio. However, if gearing is taken into consideration, ATP's indirect real estate investments become the dominant section of the portfolio.
"When we look at exposure we include gearing, because it is our total risk that we like to measure," says Nielsen. "So the indirect part of the portfolio has become the largest one. We will still be an active direct investor in the Danish market, but the Danish market is not that big and so I'm sure the fastest growth will be in the indirect part of the portfolio."
ATP's overall exposure to real estate stands at close to 5% of total assets under management. Nielsen is unable to give any clear indication as to how this might change but ATP does not have a strict target allocation for the asset class. "It might change in the future. It might be growing," he says. "But we don't have a fixed target saying, for example, we should have an 8% allocation to real estate."
Instead, ATP separates its assets into "different boxes" and real estate shares the "inflation-hedged box", alongside "the likes of infrastructure and index-linked bonds," Nielsen explains. "While we try to achieve a good diversification between the various asset types within this box, it is also quite opportunity-driven, meaning we try to source the best investments," he says. "So, we don't have a specific target for that, but my estimate is we will see a slightly growing allocation to real estate."
ATP's indirect exposure includes both mutual funds and club deals, but these invest exclusively in non-listed real estate. Nielsen is clear that ATP does not want to gain exposure to the listed property markets.
"It is mainly due to the fact that we see real estate investment as a diversifier to the other asset classes and we see a strong relationship between the listed equity markets and the listed property markets," he explains. "Furthermore, there is a tax issue where we will have a double taxation if we do the listed real estate investments."
Until this year, ATP's international investments were restricted to Europe. In June, ATP Real Estate announced that it had made its first investment outside Europe, namely into the CBRE Investors' fifth value-add fund aimed at the US real estate market. This was followed soon after by a second US investment with a capital commitment to LaSalle's fifth US-based income and growth fund.
The timing of ATP Real Estate's move into the US could be seen as tactical, given its current position in the market cycle. However, that ATP has not invested in US real estate over the past two years is more to do with practicalities than any sense of market opportunism. More specifically, the past two years have been spent addressing tax issues that needed to be resolved before ATP felt comfortable moving into the market.
"It took quite a while to get that in place," says Nielsen. "I am happy today that we haven't made any commitments over the past two or three years, because we have seen a big downturn in that market."
Both US funds will be looking to make fresh acquisitions in the market and will no doubt be hoping to take advantage of further repricing and potential distressed sales. "We hope it will be a benefit to us, that we were forced to wait quite a long period before we could make our first commitments," Nielsen adds.
ATP Real Estate works to clearly defined three-year investment programmes, and the current strategy dictates that it is only allowed to invest in Europe and the US. The move out of Europe and into the US was prompted by a number of reasons.
"First of all we wanted to gain access to further products," Nielsen says. "But we also wanted to increase our diversification to another part of the world where the economic cycle is not exactly the same as it is here in Europe. We have more than 20 European funds in our portfolio; we thought it was a good idea to diversify further, because the US market is more or less the same size as the European market."
Nielsen says the US market offers ATP Real Estate "access to a number of managers and a number of new areas", as well as a good risk-return balance. But this raises the question why the US is the first destination outside Europe when many European investors are looking instead to the high-growth economies of Asia for their main source of diversification?
"As a pension fund we are not climbing that high up the risk curve," Nielsen responds. "We will start in the more core or value-added areas and the more mature markets. For example, we would not take too high a risk by going to China or India."
However, this could well change when ATP's real estate investment strategy is revised in 2009 and the next three-year plan is established. "While I can't foresee whether we will expand the area we can invest in, we will no doubt consider whether we should expand, for example, to Asia or places where we are not allowed to invest today," Nielsen says.
For the time being, ATP Real Estate is screening both the US and European markets for investment opportunities; it is not the case that the pension fund is now fully weighted to Europe and will be concentrating only on the US market.
However, Nielsen admits that ATP Real Estate has been "very cautious" and "working very slowly" in the European market over the past six to nine months. "We have only made one new commitment in the European market during that period and that is mainly due to the uncertainty in the market," he says.
Where the pension fund is definitely adopting a cautious approach is over the UK market, which has seen a dramatic repricing since the latter part of 2007 and continues to be the focus of much debate regarding when values will hit the bottom.
"As a long-term investor, we definitely know there will be upturns and downturns over the lifetime of an investment," Nielsen says. "For example, what is happening in the UK, with a value decrease of over 20% in the last nine months - we have definitely taken a wait-and-see attitude over that. But on the other hand, we want to see if we can put ourselves in a position where we can take advantage when the market hits the bottom."
And it is not as though ATP is underweight the UK.
In addition to pan-European funds that may include exposures to the UK, the pension fund is already invested in funds specifically targeting the UK, such as Henderson Global Investors' retail warehouse fund, and two multi-sector funds managed by ING Real Estate Investment Management and Greenhills Property Management, respectively. There is always room for more investments in the UK market, Nielsen reveals, although perhaps not in the immediate future.
"The UK is one of the largest real estate markets in Europe. It is most the transparent market in Europe, so we will always have the UK as one of our largest investment areas in Europe," he says. "But we try to hit the right timing in these markets. New investments in the UK are not highly prioritised right now. This is mainly due to the fact that we will wait and see a little bit. But we still have room for further UK exposure, it is just a question of finding the right time to press the button over there and identifying the right managers to work together with."
And when it comes to identifying the right managers, Nielsen is wary of the drawbacks of working with too many. For this reason, he likes to discuss new opportunities with existing managers.
"We are still screening the European market constantly to see if there are new products coming up," he says. "But we also like to discuss new things with our existing managers, because as a pension fund we don't want to end up having 60 or 70 different managers dealing with our portfolio. We also prefer to follow up investments with existing managers."
Nielsen also likes club deals where ATP Real Estate can be "much more involved in setting up the fund". However, the present market environment is less than conducive to this approach, so Nielsen does not expect to see many opportunities in this space.
"It is not very easy to set up a club deal," he admits. "First of all we need to identify a need or window in our strategy which we would like to cover with a new fund, identify the right manager to deal with it and then find one or two like-minded investors who would like to join us. With the current market environment we don't expect to set up a huge number of club-type funds over the next year or so. We might have a few in the pipeline, but they are at the very early stages."
As for new fund proposals, Nielsen wants to see realistic gearing levels (with evidence that the fund manager is able to source the proposed debt financing) and a return to more balanced alignment of interest between manager and investors.
Gearing levels have become an important issue for ATP Real Estate. The perception held at the pension fund is that, despite the credit crunch, real estate fundamentals are still "sound and good", Nielsen says. "We haven't seen a very increased vacancy rate, rental levels are more or less the same, demand for new space is fine.
"If you look at a piece of real estate, everything looks pretty fine, until you come to the financing. That is why we have a very careful look at the financial model of a fund: where will they get the money from? What kind of bank will provide them with financing and what are the terms? Is it worth putting in so much gearing? We definitely prefer a fund with lower gearing."
However, Nielsen complains that many new products are coming to the market still suggesting loan-to-value (LTV) ratios of 70-80%.
"But the managers don't tell us where they will get this money from," he says. "With the uncertainty in the market, in terms of valuations, we definitely prefer lower gearing levels. Today the managers should be sure they can provide the financing for a new product."
Nielsen would also liketo see a rebalancing of the alignment of interest between managers and investors, because he believes that during the "hot market" of the past four years, terms have been favouring managers unfairly. "It is a very big issue for us right now to have alignment back at a more acceptable level, seen from the investors' side," he says.
"We have rejected a huge number of funds over the last six to nine months, because we simply find the terms unacceptable. But we hope that what is happening in the market right now will make the managers think a little bit more about their terms and offerings and make them more balanced."