Indirect Multi-managers continue to evolve, and the secondary trading market is the latest genetic mutation, writes Christopher O’Dea 

In short, funds of funds and multi-managers are increasingly moving away from their traditional activity of investing in funds. They are moving to a more diversified model of co-investments and secondaries, rather than focusing solely on underlying fund investments.

This year, CBRE Global Multi Manager, the indirect arm of CBRE Global Investors, changed its name to CBRE Global Investment Partners (GIP). With $12.5bn (€9.8bn) in assets under management, the unit still has a large fund-of-funds segment, but the new name reflects the increase in co-investments, joint ventures and secondary investing, says CBRE Global Investors CEO Matt Khourie. 

Investor demand was behind the change, he says. Many investors would like to buy secondaries, he says, and co-investment gives clients visibility on the assets they own.

Jeremy Plummer, CEO of CBRE GIP says the term multi-manager had carried a limited meaning, implying that the unit focused on funds of funds. “As our investment approach expanded,” Plummer says, “we realised we needed a name that conveyed not only our global investment scope but also the breadth of investment vehicles that we use.”

Other major multi-manager businesses have also diversified and added secondaries and other product areas. Aviva Investors, for instance, includes secondary investing in its multi-manager business. The company acquires interests in commercial real estate funds or limited partnerships, recapitalisation of joint ventures, and special situations involving private REITs, private real estate operating companies and real estate securities. Aviva Investors looks for situations with at least $10m in outstanding equity value, from portfolios that have been established for two to seven years, but will consider less-seasoned portfolios with unfunded commitments. As a diversified global manager, Aviva Investors places no limitation on property type or geographic location. Since liquidity is usually the primary goal for selling institutions, transactions are either all-cash or on a structured settlement basis.

Aberdeen Asset Management has also moved into secondary investing. The firm raised three real estate funds of funds in five years, ending in 2012, with an aggregate $1bn (€0.8bn) in investor commitments. Aberdeen Indirect Property Partners (AIPP), which closed in 2006, does not contribute towards that capital figure, and is also the largest real estate fund of funds ever raised. The €623m fund was the first pooled pan-European real estate fund of funds and it made commitments to 15 different core-plus and value-added funds.

Just a year ago, Aberdeen launched Aberdeen European Secondaries Real Estate with €152m of initial commitments, including a €27.7bn anchor investment from Sweden’s AP1 pension buffer fund. The portfolio will consist of about 15 funds with collective exposure to more than 200 properties in Europe, which will be drawn from an investment universe of more than 100 funds encompassing a variety of sector, single-country and regional strategies. Jon Lekander, global head of property multi-management at Aberdeen said the fund was launched to pursue “growth of attractive secondaries opportunity in this part of the market as investors are becoming increasingly active in the management of their indirect property portfolios”.

Mandates for investors in the UK are the most actively-managed at Aviva Investors, says Ed Casal, head of global indirect real estate. Property benchmarks in the UK are more established, and are based on more robust data than indexes in the US and Asia; clients evaluate managers closely against those benchmarks, spurring managers to use all available tools to outperform. Much of the $10bn managed by Aviva Investors is organised as separate accounts. “A big part of our activity is strategic, working with clients that want to make an allocation to real estate that needs to fit into an existing multi-asset portfolio,” Casal says.

The unit began accepting capital from third parties in 1997, and has continually evolved – last year Aviva Investors broadened Casal’s responsibility to include REITs. “It’s valuable to have the capital markets discussion as we’re investing on the private side,” says Casal. Integrating REITs into a “holistic approach” also enables Aviva Investors’ multi-manager team to adapt to consolidation in the underlying property sectors, he says. Clients seeking exposure to shopping malls in the US, for instance, must invest in REITs, which have consolidated the underlying real estate, rather than individual properties.

Multi-manager units now function almost as innovation labs, housing a wider range of investment talent, and concentrating on tailoring portfolios to the needs of investors. “What matters to investors is that the deals – whether they are new funds, funds on the secondary market, club deals or co-investments – give immediate exposure,” says Plummer. “The key skill is the ability to underwrite not just the funds but the assets in those funds. It’s a more demanding, higher-value offering.” 

Primaries versus secondaries
Industry data show it is taking longer for closed-ended funds to assemble their capital, while investors are pressing for better returns and more visibility about the performance of their underlying holdings. As investors have allocated more capital to private real estate funds, competition among managers for capital – and good investments – has increased apace.

Never has a track record counted for more. According to Preqin’s June 2014 Real Estate Managers outlook, only 15% of capital was targeted to first-time managers by closed-ended private funds in the market during the first half of 2014. That is a sharp drop from Preqin’s last full report on funds of funds in 2012, when 63% of fund-of-funds managers said they would commit capital to first-time funds.

From another perspective, Preqin says the proportion of investors that will invest in first-time funds has declined from 41% in December 2009 to 18% in August 2014. Correspondingly, the proportion that will not invest in first-time funds has increased from 28% of institutions to 63% over the same period.

As a result, fundraising for first-time or less experienced managers remains challenging. While just 15% of capital is targeted for first-time managers by funds raising capital in the market, the largest proportion of capital, 38%, is targeted to managers that have previously raised seven or more funds. The time required to raise money has been trending up since 2010, as well, and by mid-2014 the average time spent in the market to raise a closed-end real estate fund – the typical fund-of-funds structure – was more than 19 months for the first time ever. “The fundraising market for fund[s] of funds has been fairly slow for several years now,” says Moylan.

When funds do close, fewer, larger funds are garnering the lion’s share of assets, reflecting the increasing importance of scale in the business. Fundraising data also show the consolidation of the industry into fewer, larger vehicles. In 2011, 12 funds of funds raised an aggregate $2.4bn, while in 2012 six vehicles secured $4.3bn in equity, reaching pre-2008 levels. Three funds closed in the first seven months of 2014, raising an aggregate $718m, illustrating ongoing difficulties faced by fund-of-funds managers. Overall, the average size of real estate funds closed in the first nine months of 2014 stood at $546m, “the highest figure ever for a single year, a result of larger funds being raised by fewer managers,” says Preqin.

As it turns out, institutions are consolidating their manager relationships, and the large firms are surviving. According to a recent report on Blackstone by Morningstar Equity Research analyst Stephen Ellis, “institutional investors, particularly pension funds, are generally seeking to cull” rosters of alternatives managers “by two thirds in some cases”. That has created a difficult environment as the lengthening time to raise new funds adds pressure to fees. “A key metric for alternative asset managers is their ability to raise external capital for new funds,” Morningstar says. “Not only will the fund flows drive earnings, but they demonstrate the strength of the firm’s reputation and pricing power.” 

It is already taking longer to invest and getting harder to find good investments. Nearly 50% of managers say they are reviewing more opportunities for each investment they make, with nearly 30% reviewing 30 or more opportunities each month. But few deals make the cut – 45% of managers say that only three to four opportunities receive detailed analysis each month.

The difficulty that primary investors are having finding attractive opportunities plays to the strengths of the growing secondary market. With so much money chasing deals, blind-pool risk – the uncertainty around how a manager will eventually deploy capital – is rising. Another pressing question is: why allocate capital at full value to primary managers, which are having an increasingly hard time finding attractive rates of return?

While “the secondary space in real estate is still very small”, says Moylan, it “has potential to grow. It’s much more developed in the private equity/venture capital space, for example, but it’s definitely an area of more interest.” Moylan points to the recent $1.5bn real estate-only secondaries fund raised by The Partners Group fund as “evidence of this interest”. He says: “We’re also seeing much more acceptance in the industry of the need for a secondary market and there seems to be much more activity in terms of transactions.” 

An essential capability
One of the central tenets of secondary investing is that it removes, or at least reduces, blind-pool risk. With the time it takes a new fund to raise capital reaching a record high this year, it is getting harder for funds to start deploying capital, potentially letting attractive deals pass and increasing the vulnerability to blind-pool risk.

Investing with new and emerging fund managers has always come with a risk. The secondary market is bringing this into sharp focus and attaching numbers to it. Discounted secondary trades on funds have implications for asset allocations. Fund-of-funds managers now face the possibility that units in funds they have selected are priced at a discount mid-way through their investment periods. 

Many managers are adding secondary investing capabilities to their multi-manager groups, but specialists caution that investing in limited partner units is a different business from investing in underlying property. “You can’t do it part time,” says the head of one secondary specialist. Even though adding secondary investing to multi-managers has intuitive appeal, real estate analysis skills are not immediately transferable, he says. A commitment to a primary fund is a pledge to a manager’s proposition, and while track records are currently being used as a screening device in fundraising, new funds are essentially theoretical, he says. Evaluating the financial health and prospects for a limited partnership that is partly or entirely invested raises a host of issues, he says, ranging from the economics of the underlying properties to capital market conditions that could affect the value or availability of exit routes.

What is more, the pace of the business is substantially faster; unlike allocating to primary funds where you might have months to decide, the bidding period for secondary fund allocating is often three weeks or less. And if a bid is accepted, closing the transaction requires negotiating finesse to persuade general partners to admit a replacement limited partner, and specialised legal expertise to complete assignment and assumption agreements, and other documentation.

Casal says that is a fair assessment of the US secondary market but that secondaries are much more advanced in Europe, where Aviva invests in $300m-400m annually in secondary limited partner units. General partners for the most part allow the trading of the units, and because of its extensive portfolios, Aviva Investors often owns limited partner units that come onto the market, so the investment team already has a view on the financial condition of the fund and its holdings. When offered secondary units, the Aviva Investors capital markets team consults with portfolio managers and research analysts to determine whether a given limited partner presents a suitable opportunity for the firm to acquire or extend a position in certain markets or regions included in client portfolios.

While secondary investing is often seen as a way for institutions to raise liquidity, secondaries provide investors with the ability to quickly diversify a portfolio by vintage year, investment strategy, industry sector and fund manager. And unlike primary commitments that are drawn over three to five years, secondary capital is deployed immediately at the close of each investment since funds are typically at or near the end of their investment periods when purchased.

Casal says Aviva Investors has been assertive in using secondary transactions as a portfolio management tool to accelerate entry into certain funds. “We’ve jumped the queue to get into open-end funds, and to get into some closed-end funds, where we wanted to capture those returns,” he says. “We’ll approach some limited partners to find [one] that’s willing to sell. It’s worked well, and we’ll do more of it.”

They may soon have a crack at units from real estate funds raised between 2005 and 2008. Market sources say those funds are about three years behind their investment schedules; because of the crisis, many delayed investing or are sitting on property that is over-leveraged, increasing the likelihood that limited partners will decide to get their money out and redeploy it. One investment bank estimates that slow distributions from the 2007 vintage could mean that investors are waiting to receive as much as $34bn that would have been distributed by 2013 under normal conditions. Secondary deals could unlock that liquidity.

The business of allocating capital among a range of underlying managers continues to change. The new skill of the moment is secondary investing, and – for now – most institutional managers seem to be housing that expertise in multi-manager units that increasingly afford the most nimble way to adopt new expertise into indirect real estate strategies. 

If secondary trading volume becomes large enough, that may change. But, for now, the message for indirect managers is clear: “This business has become much more sophisticated,” says Casal.