Is there a need to rebuild trust between investors and fund managers? As Richard Lowe discovers, good, professional managers invariably still have the trust of their investors, but are doing everything in their power to maintain it

The past 18 months has been an extremely difficult period for institutional real estate funds: performance is in negative territory; leverage levels were in many cases too high and are now warranting capital injections; valuations of underlying properties are often unclear; some investors are having difficulty funding capital commitments; and fee structures are no longer maintaining an alignment of interest.

Given this picture, is there a need to rebuild trust between investors and fund managers? Certainly, there is a growing consensus that those managers that are transparent and forthcoming with their investor communications about problems in their funds will stand a much better chance of coming out at the other side of the crisis with their reputation and the potential for future capital-raising intact.

"If you want to maintain your business in the future and set up new funds down the road, I think it is absolutely critical to maintain the trust from investors at this stage," says Lisette van Doorn, chief executive at the European Association for Investors in Non-Listed Real Estate Vehicles (INREV)

Looking back, investors will judge managers just as much on their transparency during this downturn as performance, says Jeremy Plummer, managing director at CB Richard Ellis Investors' multi-manager business. "Those that were very transparent about the real situation they were in and who handled the negotiation of their banks and any complex financial restructurings successfully will obviously be the winners. And those who were not very transparent about it - perhaps were in a bit of self-denial about it, didn't take action early enough and got into really serious problems because of that - will end up being the losers," Plummer says.

"But especially on the transparency count, if investors in this environment feel managers are in a sense hiding the extent of their problems, the loss of trust that will come from that will be permanent. That is the biggest risk that managers face: if they are not transparent, they risk losing the trust of their investors. Losing money is one thing, losing trust is something else."

Jos Short, founding partner and chief investment officer of Internos Real Investors, says this issue of trust will be positive "for those managers who are open, honest and transparent, with good quality reporting and credible plans to get funds out of their gearing issues". Short estimates that this would apply to about 50% of the current fund manager universe.

Ric Lewis, former CIO of AEW Europe and founder of Tristan Capital Partners, believes it really comes down to the specific relationships between individual investors and managers.

"It's kind of like saying: ‘Is there a need to rebuild relationships between husbands and wives because the divorce rate is so high?' Well, it depends on what is going on in that relationship," he says. "There certainly is the need in some relationships to rebuild trust, but I don't know if it extends to the whole industry."

Neil Turner, head of property fund management at Schroders, is wary of exaggerating the need to rebuild trust across the industry. "I think there is a danger that we overstate the breakdown that there has been in some areas of our industry between the fund manager and the investor," he says. "There are, of course, a few incidents where the fund manager has acted inappropriately and not in the best interests of the investors.However, I think the large majority of professional fund management houses appreciate that their clients' trust is essential to their long-term commercial success."

Many in the industry agree that it is more accurate to say there is a need to maintain trust rather than rebuild it. Allan Mikkelsen, partner at ATP Real Estate, is happy to see a rebalancing of power between investors and managers, which in the past he thinks was too heavily weighted to towards the latter. But he does not believe there is a need to rebuild trust as such. "That wouldn't be right," he says. "We still trust in the manager, in general, with which we have invested."

Van Doorn agrees. "The word ‘rebuilding' sounds wrong to me, because that sounds as if trust was completely gone," she says. "In any kind of catastrophe you need to trust the people you are dealing with. In that sense, of course, it is an important topic, but basically it always is - you have to be able to trust the people you are dealing with."

Jeroen Winkelman, portfolio manager for European indirect investments at BPF Bouwinvest, confirms this is a fair analysis of the situation. Fund managers are doing "everything to keep the trust. They are being very creative to get the best out of it, because they know if they lose investors their reputation is at stake."

Van Doorn says that what is more important to investors than fund performance - which is suffering across the board - is ensuring they can trust their fund managers to negotiate current problems and return to delivering good performance in the future.

"The most important thing is what do you need to be able to trust the manager? There the emphasis should lie on transparency, reporting, etcetera," she says. "Being able to trust your manager right now is most important, because current performance doesn't deliver it, so they need something to be able to say: ‘okay, we're in difficult times right now, but I can see this fund manager pulling us through and it is going to be positive again in the future'."

Furthermore, Van Doorn argues that trust between investors and managers is a two-way street. "Fund managers need to be able to trust investors in the fund," she says. "They should do their share in delivering to the fund manager. We have also heard about investors defaulting on capital calls. To me that is also an issue of trust, so it is not a one-way issue."

This was a point voiced by Chris Morrish, managing director at GIC Real Estate, when he spoke at this year's annual INREV conference in Athens. "I don't think investors can and should blame fund managers for the circumstances we all find ourselves in today when fund managers have actually executed the strategy that investors have signed up to," he said. "We are all supposed to be professionals and we should all be aware of what we are going into."

He added: "I come back to the word that is used in all fund documents, but has perhaps not been as prevalent as it might have been in some of these funds, and that is ‘partnership'… we all need to emphasise we are in it together. Fund managers need to run a business and make a profit for themselves and to provide a service for investors; the investors provide the capital. But the whole point is we need each other, and the best funds are going to be where the two sides work together in partnership and both have full integrity."

One criticism levelled at some fund managers is the levels of leverage employed that are now causing widespread problems. Consequently, appetite for higher levels of leverage seems to be waning on the part of investors. But investors signed up to leverage levels in funds willingly in the first place, so should they be taking equal responsibility for any negative effects they may be experiencing?

Van Doorn thinks so. "They signed up to it and it was stated in the fund documents what the level of leverage was: the target and the actual," she says. "With hindsight we would say that many leverage levels have been too high, but that is easy to say… because we were all there when funds were launched with such high leverage levels. So I don't think that is the issue. It is almost useless looking back, because you can't change it. You can change for the future and hopefully we've learnt something from it."

Instead, she believes the main issue for investors is how managers are managing debt in the fund at a time when debt financing is less available and more costly. "Refinancing issues that might come up; payment of the interest amounts that need to be done. Those are the critical issues," she says.

Another is ensuring alignment of interest between investors and managers, particularly given that many incentive fee structures have become ineffectual due to the severity of the market downturn.

"Many fee structures did not take into account an alignment structure that fees should always be seen in the broader perspective. They only assumed further upturns and positive outcomes," van Doorn says. "No one - or hardly anyone - expected that you might also need alignment when the market went down. That is a critical area they are focusing on now: how to make sure the fund manager stays aligned with the fund also in the current market circumstances."

Investors are faced with a difficult conundrum in this area. If the fund manager is no longer incentivised, should investors agree to revise fee terms to enable general partners to be rewarded for a more conservative level of performance? On the other hand, it could be argued that fund managers have benefited from the upside of their alignment models during the boom years and so to change fee structures now would mean they would also benefit from avoiding the downside.

The subject was raised at IPE Real Estate's Investor Forum in Amsterdam in May. Conference chairman Piet Eichholtz, professor at Maastricht University, questioned whether this approach was simply "changing the rules to suit the fund manager". Yet, Andrea Carpenter, director of research and market information at INREV, stressed that it should be remembered that the severity of the downturn is unprecedented. "They have fallen out of their performance fee structures so badly, investors could say ‘tough', because it is a tough market," she said. "But the investor wants to keep the fund manager motivated. You don't want to just say ‘tough'. It is going to take some recalibrating."

Investors are generally in a stronger bargaining position than they were during the boom years, and so are potentially in a position to take a hard line with managers over fees. In Amsterdam, Eichholtz, playing devil's advocate, suggested that perhaps it was all about power and that investors should perhaps exercise it. "I think this is a time for reflection, not just for beating up your fund manager," Carpenter countered.

Mikkelsen is happy to see a rebalancing of power between investors and managers. But he agrees with Carpenter that the pension fund investor is not looking to ‘beat up' its fund managers.

"We are not here to take advantage of general partners now," he says. "That is not the idea at all. We just want a balance and clear respect for what capital is being invested. And the ATP capital is for 4.5 million pensioners' money and we certainly have to respect that, and our general partners have to respect that."