The state pension fund of Finland is aiming to grow its real estate exposure over the coming years. But managing director Timo Löyttyniemi tells Richard Lowe how the current market uncertainty has prompted VER to review its existing investments

Valtion Eläkerhasto (VER), the state pension fund of Finland, began investing in real estate four years ago, since when it has built up an exposure that accounts for 3% of its total multi-asset portfolio. The long-term intention is to increase this weighting, but given the current environment of financial turmoil and economic uncertainty, Timo Löyttyniemi, managing director at the fund, says he is happy to take his time in looking for new investments.

At the moment, the focus is firmly on monitoring the progress of its existing real estate commitments, whether it be scrutinising leverage ratios in existing funds or keeping up to date with what fund managers are planning to do over the next few months.

"We have not been that aggressive in terms of making new investments currently," Löyttyniemi says. "In the current market turmoil I don't think we have to hurry at the moment. We are looking and seeing how the market is going to behave and at the same time we have been following our current exposures."

The €11bn pension fund is relatively new to the real estate asset class and has only ever invested in non-listed real estate funds, with the exception of a small exposure to listed property. It has investments in three pan-European funds of funds and a number of single European funds, including three focused on its domestic real estate market.

In 2008, VER made its first foray outside of the European markets and invested in Franklin Templeton's Asian fund of funds product. Löyttyniemi explains that this commitment was the "first step" towards creating a more international real estate portfolio. However, he points out there are no plans in place to enter the US market or, for that matter, any plans to further increase its exposure to Asia Pacific. "We will see what we learn from this and, based on that, we will make the next moves," he says.

A fund of funds approach was deemed the best way to gain an initial exposure to the region and learn about the markets. "For the first investment we are happy to deal with a fund of funds type of product," Löyttyniemi says. "Later on we will see whether other suitable instruments are available for us."

Real estate is included within VER's broader allocation to "alternatives", accounting for approximately 30% of this segment of the portfolio. At VER, alternative assets also encompass investments in private equity funds (specifically buy-out, mezzanine and infrastructure vehicles) and absolute return funds (predominantly funds of hedge funds). The target allocation for alternatives is 10% of the entire VER portfolio.

The key issues for real estate as VER heads into 2009 concern whether long-term interest rates will remain low enough to support the asset class, especially considering that the inevitable economic slowdown will bring about a deterioration in vacancy rates.

"The interest rate fall is certainly benefiting real estate assets and giving some back up to its current decrease in valuation prices," Löyttyniemi says. "But at the same time, of course, estimates for next year's economic slowdown are quite severe and that certainly will affect the vacancies for some of the real estate assets. The returns on some of the funds must be quite mild going forward."

Having said this, a downturn in real estate markets can produce opportunities as well as difficulties. VER has not invested in any opportunity funds with specific strategies to target distressed properties or distressed owners. But when asked whether he is hoping or expecting his fund managers to seek to capitalise on distress in real estate markets, Löyttyniemi says this is largely an issue for the general partners to decide on at their discretion - although he would be happier for fund managers to invest in distressed opportunities only if there are healthy capital reserves in the fund.

Fortunately, Löyttyniemi believes the difficult market outlook will ensure that general partners are more cautious with their investments and this will naturally create a better alignment of interest with investors than was possibly experienced during the recent boom years. "During this financial turmoil, everybody must be more aware of various transactions and so all fund managers are looking for the best interests of investors," he says.

Another potential opportunity that has come onto the radar for VER is the significant discounts to net asset value in the listed real estate sector. The pension fund has invested in the sector in the past on the limited basis and Löyttyniemi does see there is a case for investing at the moment.

"Certainly, the current timing is of interest for at least following the public market and whether that is more attractive than the private one right now," he says. But while the opportunity has been discussed internally at VER, there are no plans as yet to make any new investments in the listed sector.

The same can be said for real estate derivatives, which VER investigated as a possible investment opportunity three years ago. Löyttyniemi explains that the pension fund is not currently active in the sector.

One of the biggest concerns relates to how counterparty risk could be managed.
"Some of these certificates are issued by large investment banks," he says.
"The question is: if there is a counterparty risk, how do you
manage it?"

Valtion Eläkerhasto at a glance
Total AUM:
€11.9bn (30 September 2008)
Alternative AUM:
€1.12bn (30 September 2008)
Proportion of alternative assets
allocated to real estate:

29.6% (31 December 2007)
Total returns:
-6.4% (January-June 2008)
Alternative total returns:
-1.0% (January-June 2008)