Joint ventures are an increasingly popular investment route. But how well are they doing? Shayla Walmsley finds out
Why do pension funds opt for joint ventures? There are good reasons to do so. Risk diversification, for one; the opportunity to invest in projects that are too big to take on alone, for another.
But in fact what has driven the current fetish for joint ventures is not their intrinsic merits but the perceived failures of funds. The appeal of joint ventures increased as the appeal of funds decreased.
"There was a backlash against pooled property funds, with investors looking at other models," says Andrew Smith, head of property at Aberdeen. "It was a retreat from indirect investments, which had been in vogue at that time. To some extent, it has been a temporary phenomenon."
But some of these agreements, as they mature, are beginning to show their own faultlines. The greatest inherent exposure for JV participants is, of course, to counterparty risk. FSP Pension, the DKK 21bn (€2.8bn) Danish scheme for financial services sector workers, attempts to mitigate it by forming joint ventures exclusively with other pension funds.
"We only do joint ventures with people we know and trust," says director Steen Jørgensen. "Our counterparties are always pension funds because then we have alignment of interest. They may have different attitudes on many issues but pension funds are long-term investors, whereas most people in the business are short-term investors."
The scheme, which has 12% of its total portfolio allocated to property, announced in September that it had teamed up with Lærernes Pension, the DKK40bn Danish teachers' pension plan, in a DKK400m (€53.7m) residential development joint venture in Århus, Denmark's second city. The project, Emiliendalen, is scheduled for completion in 2012.
Another advantage of undertaking JVs only with other pension funds, according to Jørgensen, is that they tend to want to make long-term costs as low as possible - in contrast to construction firms, whose focus is on immediate costs. "Pension funds will invest in better quality bricks because better materials make costs lower in the long term. They have a five to 10-year perspective," he says. "Short-term investors, in contrast, will keep immediate costs down even if using cheap materials means costs increase in the long term."
Knowing who you're dealing with at the outset helps joint venturers anticipate what will happen if the partners' strategies change further down the line. Arguably, the more aligned the investors, the more likely they will be able to anticipate the requirements of all.
An alternative approach is to factor in diverse and potentially conflicting interests in advance. Leo de Bever, CEO of the Alberta Investment Management Corporation (AIMCo), which manages assets worth CA$71bn (€51bn) for 26 Canadian pension schemes and government funds, points out that operators won't have the same interest in the asset as pension funds, which is why both sides need an ironclad operating agreement. "It's the same in real estate development, where one partner does the engineering or the developing, and the other partner provides the finance. You need to understand where you're not aligned, and how any disputes will be settled. You also need an agreement on pricing," he says.
AIMCo in August agreed a JV with fund manager Kingsett Capital for the acquisition of the remainder of the CA$2bn ING Summit Industrial Fund. The deal included the 7.8% of the fund owned by an Australian investor and the separate acquisition of ING Real Estate Canada.
For de Bever, JVs are as much about risk sharing as risk mitigation. "I used to work for an organisation where the CEO didn't want partners because he thought they were trouble," he says. "But for experience, and experience of specific kinds of risk, you often need a local partner, depending on the type of asset. With infrastructure, joint ventures are an opportunity for those with little experience of acquisitions. We've done a lot of acquisitions but we haven't necessarily operated certain kinds of assets. So we might work with people with a complementary skillset."
Even where there is supposedly alignment at the outset, JVs are no more fixed than markets are. As IPD director (and former head of global research at RREEF) Peter Hobbs points out, both market and investor circumstances can change quite dramatically over a JV's lifetime - and some have become messy over time, as each partner attempts to anticipate the other's positions. "The big issue is shared
interest and alignment over the medium to long term," he says.
What those who have made joint ventures work and those who advise them agree on is that it all happens at the beginning of the deal. "If you invest in a fund, there are a whole set of processes on the strategy and life of the fund," says Hobbs. "With a joint venture, you have to spend time and effort at the outset on governance, structure, and the processes that will govern it. There are the hard tangible areas - legal, financial, tax, structuring advice - but also softer areas around governance, operating processes and the role of the other external advisers such as asset managers and property managers."
When FSB sets up a joint venture, the scheme lays down rules for a 10-year period, including guidelines and agreements. "We negotiate what to do if there is a change - such as whether we will have to find another partner or sell the asset," says Jørgensen.
"For example, if one of the assets owned by the joint venture is an apartment, we could ask the tenant occupying the apartment whether they want to buy it. There are various ways to sell off assets if one of the parties wants to move out of the joint venture. It will all be in the written guidelines."
This emphasis on the groundwork could make it sound too easy - if you get it right at the beginning, then the whole thing will run smoothly. That isn't necessarily the case. Reassured by the fact that the pension fund partners have guidelines - "you can be sure they will follow their own standards," says Jørgensen - FSP Pension nevertheless meets its partners several times a year to discuss budgets and maintenance. Loss of interest is a serious risk.
With JVs coming somewhere between direct ownership and fund investment, pension schemes need to know the difference. What is clear is that joint ventures demand significant internal resources - which is perhaps why sovereign wealth funds have taken to them with alacrity. Yet Claude Angeloz, co-head of private real estate at Partners Group, isn't sure joint venturers always understand that. In many cases, he suggests, investors are not prepared for the effort involved in making them work.
"Since the crisis broke out, there's been a lot of talk of investors being able to impose investment terms - to be more involved in their investment and to have more control over it. It's tempting for the investor to say, ‘This is what I want'. But they need to be aware that if you set up a joint venture, you're investing in the process and the decisions, and that potentially creates a conflict.
"If anything goes wrong, the investor will be co-responsible for the investment decisions that led to it. The investor won't be able to point to the fund manager over performance a few years later. If the fund manager doesn't deliver, that reflects also on the investor. Each side will point the finger of blame at the other side."
He adds: "It's a risky approach and they won't be in control of their destiny. If you're investing with partners for at least a decade and you have a strong team, that's one thing; but if you are a team of one or two people and you want to do it, I'm not sure you're adequately resourced.
"If you don't do it properly, a joint venture becomes an adventure for the rest of its life."
The limits of DIY
If there is a formula for a successful JV, it is: many assets, few partners.
As de Bever points out, partners offer more talent to look at the transaction and potentially a different perspective on risks and opportunities - but, Smith claims, only or especially for a small group of investors. "The model relies on parties wanting a long-term relationship," he says. "What works in the short term won't work in the long term."
In any case, cost-wise, JVs are not worth doing unless we aggregate the assets to make the benefits justify them. "There's also the difficulty of investing, especially in the right kind of assets at the right time," says Hobbs. "If you've done three, or four, or five joint ventures, you've created a track record and you'll probably continue to do them."
Much of this could well be academic. If joint ventures have come into fashion as funds have gone out of fashion, what's to stop funds coming back again when the shine comes off joint ventures?
Will they simply go out of fashion? Not necessarily, but there is likely to be a revaluation of whether they are a credible option for smaller pension funds.
Future joint venturers will be large pension funds, given the volume of internal resources required to make them work. "Direct investments with investment partners require more resources, and a higher degree of skill than investors often have," says Angeloz. "The amount of work and brain damage you put into those deals is the same as the GP's. It is totally naïve to believe that you can take it off a silver plate."
About the newcomers, Hobbs, at least, is not so sure. "Joint ventures will continue to be an alternative to funds, but not as alternative as they were a year ago," he says. "On the other hand, as the services that support joint ventures deepen, there could well be more of them."
For less-than-large pension funds, there is likely to be a drift back towards commingled funds. "The reaction against funds is cyclical," says Hobbs. "Joint ventures are time-consuming to structure. All the management provided by fund managers, investors have to do themselves. There's a growing recognition of the work involved."
The implication is that once funds have got their act together, the shine will come off joint ventures. Smith claims to have seen in the past six months a marked revival of interest in funds with attractive fee structures. "Funds tend to be more competitive: there's money coming back into the market," he says.
"Joint ventures won't go away. They're good for large investors, such as sovereign wealth funds. Joint ventures have always had a place, with owners getting together to buy assets they couldn't afford on their own. What was unusual was not the interest in joint ventures but the retreat from property funds.
"What damaged funds was a combination of the impact of debt on performance and illiquidity, when investors were unable to get out of them. Some of those issues have now been addressed.
"The impact of illiquidity and debt effects was painful but the rethink has put the right focus on the underlying real estate," he adds. "People were investing for performance but they got performance based on highly volatile financial instruments. There has been a shake-up of instruments, with performance incentives, liquidity provisions, and the investment of managers in the fund. But there was a high cost of learning."
In short, rather than being an alternative to investing in funds, joint ventures will be one more option - and not one for the fainthearted.
"Frankly, it's always easier management to have one owner and one investor," says Jørgensen. "But many deals are just too large to involve a sole investor. In that case, joint ventures with other pension funds are a way forward."