US - The California Public Employees Retirement System (CalPERS) has overhauled its real estate strategy to focus on core investments with a significantly heavier weighting to its domestic market.

The pension fund giant has also revealed it will concentrate on separate account mandates rather than investing in commingled funds, and seek to remove listed investments from its real estate allocation.

It is a significant departure for CalPERS and a development that the rest of the institutional investor community in the US will be watching with interest.

Low-risk, core investments will now make up 75-100% of the pension fund's real estate exposure, a radical U-turn on its current target of between 20-80%.

Higher-risk, private equity-style investments will be downgraded from 40% to a target of 15%.

Even more striking is the decision to reduce CalPERS' international weighting from 50% of the total property portfolio to just 15%. This is likely to be a source of disappointment for real estate fund managers in Europe.

CalPERS did indicate it would allocate capital to the emerging markets of Brazil, India and China to capture the demographic shifts taking place in the countries.

But it is the decision to eliminate real estate investment trusts (REITs), currently representing 7% of the portfolio, that has attracted immediate controversy.

The decision coincided with the launch of a report by the National Association of Real Estate Investment Trusts (NAREIT) that shows that real estate portfolios that blend listed and non-listed investments exhibit lower volatility.

The trade body was quoted in the Wall Street Journal as saying the move by CalPERS was "inappropriate" and "ill-advised".

One of the pension fund's investment advisers Wilshire also raised concerns about removing listed investments from the real estate portfolio.

The consultancy noted that CalPERS was still likely to retain an exposure to REITs through its global equities allocation, but warned that this had implications for liquidity management.

In a memo to CalPERS, Andrew Jenkin, managing director and principal at Wilshire, said: "Removing any REIT allocation from the real estate portfolio forces every other asset class to be the 'bank' for liquidity needs of the real estate programme."

Jenkin said this should not be a problem during normal conditions, but in times of illiquidity could place "stress on other asset classes" and by extension the fund as a whole.

Pension Consulting Alliance (PCA), another investment adviser, showed support for the new real estate strategy.

In a memo, it said: "PCA believes a focus on domestic core properties achieves the new role of the real estate asset class and reduces risk, as measured by volatility, in the overall portfolio.

"Additionally, the proposed strategic plan also incorporates lessons learned from the previous downturn, where the system suffered substantial losses in the value of its real estate portfolio."