During the crisis leverage, liquidity and asset allocation have provided key lessons for pension funds. The main challenges include transparency, asset management and portfolio reconfiguration. Richard Lowe spoke to six pension funds about their thoughts as the end of the decade approaches.

NAME: Stein Berge Monsen
POSITION: Senior portfolio manager
ORGANISATION: Vital Forsikring
TOTAL ASSETS: NOK229bn (€27bn)

Stein Berge Monsen, senior portfolio manager with responsibility for Vital Forsikring's real estate investments, has learned a number of lessons from the crisis. The first - and one that has been referred to by many investors - is the true extent of the downside risk when using leverage. Monsen expects to see lower leverage levels in funds in future and admits he has a reduced appetite for leverage, despite the fact that the onset of a market recovery is probably the best time to use it.

"If there is a recovery, the more leverage you have the more money you will earn on it," he says. "So that is one of the things being discussed: should you have much leverage or you should you reduce it? I think the level of leverage will go down a lot."

Other lessons include the importance of positive alignment of interest, which Monsen says has been key to the "success of funds", and the fact that the skills of fund managers are generally "more limited" than he previously thought. In terms of the latter, Monsen has concluded that very few managers have the necessary scope to deliver broad cross-border strategies, such as balanced pan-European funds. In future, Vital will concentrate on vehicles with sector and country-specific strategies.

Vital cut its exposure to equities heavily during the early stages of the crisis and with a sizeable existing real estate portfolio (16-17% of total assets) the priority for the institution is not to make new property investments. Therefore, most of Monsen's time is taken up with managing existing direct assets.

That said, Vital is very much committed to real estate - in fact, it was one of the best-performing asset classes for Vital during the crisis - but Monsen is constrained from making new investments in the short term because of wider asset allocation decisions.
Monsen is aware, though, that investors who are not in a position to commit new capital to real estate in the 2009-10 period - and he believes most investors fall into this camp - are in danger of missing out on what is "probably one of the best vintages we will see".

Hermann Aukamp
POSITION: Chief investment officer and director of real estate investments
ORGANISATION: Nordrheinische Ärzteversorgung (NAEV)
REAL ESTATE ALLOCATION: 10% (target 10-14%)

One of the lessons learned at Nordrheinische Ärzteversorgung (NAEV), the German doctors' pension fund, is the importance of asset allocation within real estate portfolios. This is arguably even more crucial to investment performance during cycles than factors such as manager selection, says Hermann Aukamp, CIO and director of real estate investments at the fund.

Having the right mix of investments from direct assets to non-listed and listed indirect exposures is paramount as well as having the capacity to be proactive and adjust weightings according to changes in the markets. This is especially true of listed property.

"Try to be proactive, especially when you are invested in listed real estate," Aukamp says. "You have to take certain decisions quite early on, whether to get in or get out if you work in this listed segment." He admits this is a difficult feat to achieve, something that necessitates discussions with managers but also strong in-house convictions. "This time it worked well for us, so we are on the right side," he says.

Another lesson learned is the importance of being familiar with fellow investors in non-listed vehicles. "It is not only the manager that is crucial, but also the position of the co-investors in your funds," Aukamp says.

"We learned it was very useful to have some real estate where we are the sole investor," he adds. These segregated investments enabled NAEV to ensure its managers were being proactive in responding to the changes in the markets. The pension fund was able to reduce its exposure to central Europe in the first half of 2008 because of such an arrangement, but Aukamp notes that in commingled funds there were often a lot of discussions but very little actual decisions. "It was too late. It is all about decision making in certain market times," he says.

Take advantage of investment opportunities while maintaining a defensive approach. Aukamp says he will be targeting shorter investment times. "We can't look at a cycle for three years now. It should work in a much shorter time or not," he says.

NAME: Philip Menco
POSITION: Chief executive officer
ORGANISATION: De Eendragt Pensioen
TOTAL ASSETS: €1.1bn (€800m liability hedging portfolio; €300m investment portfolio)
REAL ESTATE ALLOCATION: 60% of investment portfolio

Long term, De Eendragt Pensioen will reduce its heavy weighting to non-listed real estate as part of a general downsizing of its non-liquid holdings across asset classes. This is in response to one of the biggest lessons learned from the crisis: that liquidity is more important than investors previously believed.

Philip Menco, CEO at De Eendragt Pensioen, says this applies to real estate and other investments, and is likely to lead to a strategic restructuring of the portfolio to the extent that De Eendragt's sizeable direct property portfolio in the Netherlands is reduced.

The fund's indirect cross-border investments will not be affected as much. Many of these are at an earlier stage and are in the process of being built up, but its overall weighting to real estate may shrink as a result.

Another lesson learned is what Menco describes as the "asymmetric situation" that has often resulted from high levels of leverage used in the non-listed real estate sector, especially in commingled funds.

"In the good times you make an extra decent profit, in the bad times you could go bankrupt. That is of course much worse than the few per cent extra you have earned in the good times."

But the main challenge facing De Eendragt is reducing its large direct real estate holdings. "That is not too easy at the moment. It is difficult to find a buyer and we are not a distressed seller, so we are not willing to sell at any price," Menco says.

NAME: Edwin Meysmans
POSITION: Managing director

One of the main things that Edwin Meysmans, managing director at KBC Pensioenfonds, learned from the financial crisis is not so much a singular lesson, but more the confirmation of his long-held belief that listed property securities or real estate investment trusts are not truly real estate.

"You are not investing in real estate, you are just investing in real estate securities, which are basically equities," he says. "And we have seen that in this crisis again - that what you expect and why you invest in real estate is to get some diversification and some stable, inflation-linked income. It makes no sense whatsoever that buildings would decrease by 50% in one year and now go up by 30% in three months."

The pension fund for the Belgian KBC bank has endeavoured to reduce its listed real estate exposure in recent years, and to replace it with a diversified portfolio made up of secure, inflation-linked, income-producing investments. These include direct local assets, but also investments in foreign infrastructure and timber funds. But the latter too has been affected by what has been happening in the public markets, Meysmans says.

"We have also learned that our infrastructure investments did not turn out to be as we expected or what was promised: a very boring, stable, income-producing, inflation-linked type of investment. We've seen that a lot of the so-called economic infrastructure - the airports, the toll roads - were hit pretty hard," he says.

KBC Pensioenfonds now sees social infrastructure as more attractive, since it is less recession-sensitive, but Meysmans says there is a distinct lack of investment opportunities in this sector.

The main challenge faced by the fund is simply continuing to reduce its listed real estate exposure. "We started off with 90% of it being listed real estate. It came down to 50%.

We want to reduce it even further, but obviously not at current prices," Meysmans says.

NAME: Michael Nielsen
POSITION: Head of real estate
REAL ESTATE ALLOCATION: 4% (no fixed target; currently €2.5bn)

As well as direct investments, ATP  is invested in a large and diverse portfolio of real estate funds, targeting markets in Europe and the US. Michael Nielsen, head of real estate at the Danish institution, says the biggest lesson of the crisis has been the impact at the fund level on some of these vehicles. Even the worst-case scenarios originally projected by ATP did not reflect the true impact of the recent market dislocation.

For example, Nielsen would never have predicted the dramatic falls seen in the UK real estate market. "We would not have expected that property values would have fallen so rapidly and so dramatically as we have seen and over such a short period," he says.

But this does not apply to the UK alone. "It's in the UK that we've seen the worst example, but we've also seen it in central and eastern Europe, where markets have dropped nearly overnight. It makes us think a little bit about how quickly managers should invest their money and whether they should spread their investments over a longer period of time."

ATP will place greater focus on the impact of leverage, "both in terms of how it can affect the returns but also whether the managers will be able to achieve the financing they expect to use in their property funds," Nielsen says.

Nielsen sees a number of challenges ahead, not least maintaining a "high level of monitoring" of existing funds. The pension fund is particularly interested in whether managers have the capability to deal with a range of issues and situations.

"So far in the crisis most of the impact has been from financial issues. Now we are facing more property-related issues with pressure on rent levels, growing vacancy, etc,"
he says.

"Now we have to see whether managers are able to handle all these challenges in the various funds. In the last two years they have only been dealing with loan to value breaches and covenants in general, but now we have come back, let's say, to work with the real estate - to handle vacancies, tenants and pressure on leases."

NAME: Mikko Räsänen
POSITION: Head of private equity and non-listed investments

Real estate is a more volatile asset class than was previously understood, says Mikko Räsänen, who is responsible for Ilmarinen's non-listed real estate investments. He adds that this is particularly true of the property funds sector, which primarily uses gearing. (Ilmarinen is not legally entitled to use leverage for its direct property investments in Finland.)

"There are some elements compared with direct investments which make it more volatile," he says. "If you are investing indirectly in unlisted real estate funds you are not gaining totally the risk-return profile of the underlying unleveraged real estate investments."

Räsänen's perception that real estate is more volatile applies to pure unleveraged property assets as well. "Nowadays there is a much stronger link between the capital markets and the real estate markets, and I think it will cause more volatility to these direct investments," he says.

This change in perception will not result in any "major changes" to Ilmarinen's investment strategy, other than that the pension fund is likely to seek lower levels of leverage when investing in funds in the future. Räsänen says he will be "selective in terms of our new investments" and will spend more time on due diligence.

The main challenge ahead, he says, is for the non-listed real estate funds sector to address issues of transparency and reporting, especially following a market period when "market visibilty" has been so weak.