Are investors focusing on the wrong thing when they fixate on the risk associated with fellow investors? Richard Lowe investigates.
One of the clearest trends to emerge in recent years is the focus on investing alongside 'like-minded' investors. For years, alignment of interest equated to fund manager remuneration and co-investment - whether the interests of fellow investors in a fund were consistent was of limited concern.
Lessons have been learnt. Some investors defaulted on their capital calls, others sought to pull out of funds to the detriment of others. It became quickly apparent in a number of cases that interests were most certainly not aligned. A recent survey by the Association of Real Estate Funds (AREF) found that disagreements between investors were regarded as "more heated and intractable than disagreements between the investors and the fund manager".
This is one of the main rationales driving the popularity of joint ventures and so-called club deals, or club funds. The other is a greater desire for 'control' among large investors dissatisfied with the performance and behaviour of fund managers (and their inability to exert any influence on this). It is the first line of thinking that needs questioning.
The fixation with 'like-mindedness' is perhaps more responsible for the emergence of 'clubs' than joint ventures. Club funds in many cases are structured in the same way as traditional funds, the only differentiating factor being the number of investors they contain. They might have tighter investment parameters and/or investor sign-off on individual investments, but they are not fundamentally distinct.
The rise of club funds can be explained simply as a product of investors' preference for like-mindedness, while fund managers would happily have welcomed a greater number of investors had the appetite been there.
One fund manager, who wishes to remain anonymous, told IP Real Estate about how more than 20 institutional investors were close to signing up to what would have constituted a €1bn pan-European fund, but baulked at sitting alongside so many other investors.
Unfortunately, the strategy of the fund required this scale of investment, which would be impossible to replicate with far fewer limited partners, even if individual ticket sizes were increased.
It seems in this case investors wanted the best of both worlds, but were unwilling to compromise over their concerns about investor alignment. This poses a real challenge for fund managers.
A Danish pension fund real estate portfolio manager, who will also remain anonymous, told IP Real Estate at MIPIM last week that the institution was very much in the JV/club deal camp. The appeal of pooled funds, he believed, would not return for the foreseeable future. And he didn't consider himself a large investor and disagreed that club deals were the preserve of the largest.
That said, he admitted it was impossible to guarantee like-mindedness among investors even though this is what he desired. What an investor wants today can be very different to what it will want in five years' time.
Strategies change, priorities shift, heads of real estate move on, and trustee boards are replaced. For these reasons, is the risk associated with fellow investors actually one that is possible to mitigate? Or is it simply a risk that must priced in - in other words, a necessary evil - comparable to, say, currency risk?
Are investors focusing on the wrong thing? Is like-mindedness a red herring?
It is interesting to see the capital-raising market for real estate funds in the US in a much stronger shape compared with Europe. A growing number of fund managers are achieving final closes on new products.
This theme was picked up at the INREV seminar in Cannes last week. Simon Redman of Invesco Real Estate, from the audience, noted there were few signs the fund model had changed in the US. Gabi Stein of Tishman Speyer Properties suggested it could be that real estate fund investors in the US had already been through a market cycle and were less surprised by recent difficulties in funds - and as a result felt less compelled to challenge the model.
Speaking to IP Real Estate this week, Joe Valente at JP Morgan Asset Management recalled seeing INREV debate the future of real estate funds two or three years ago. Since then, he has increasingly moved towards the conclusion that the market is experiencing a "pendulum swing" rather than a "structural shift".
There are merits in joint venturing with best-in-class operators, he said. He also acknowledged that "a level of arrogance" among certain fund managers had tainted the fund management industry. "But the view that funds are dead is wrong," he said.