Founded in 1926, Zurich civil servants' pension fund BVK now caters for nearly 90,000 members. It has a real estate allocation that is large by European standards both in terms of its absolute size and the proportion of domestic assets. With CHF21bn (€12.9bn) of assets under management and a small and illiquid local market, the fund has now put in place a programme of global diversification. BVK's head of asset management Daniel Gloor sets out the fund's strategy and main challenges ahead to Martin Hurst

What role does real estate play in your portfolio? What is the reason behind the current real estate allocation size and composition? Why have you been so focused on Swiss direct real estate for so long and was it difficult to invest effectively in such a small market?

Real estate investments have been and will always be an important part of BVK's tangible assets (ie, equities, real estate, private equities). BVK started in 1975 with direct Swiss real estate investments which made up 6% of total assets at that time. As of 30 June 2007, the direct Swiss real estate investments account for 15.4% of total assets and represent a market value of CHF3.4bn (€2.1bn) The majority of investments are located in the German part of Switzerland, especially the Canton of Zurich.

BVK is an important player in the domestic real estate market and is either investor or co-investor in landmark buildings in Zurich such as the Swiss Stock Exchange, the World Trade Center or the Sunrise Tower. In Switzerland, BVK always focused on direct investments due to the favourable long-term risk/return figures of this investment class; furthermore it would not have been possible to invest the annual budgets for real estate only into indirect investments like mutual funds or foundations - this is not only because of BVK's considerable investment size but also for reasons of avoiding high costs and sometimes high premiums on indirect investments.

Furthermore, there are too few Swiss indirect vehicles in which to invest our target CHF600-800m. In the last three years, however, it turned out that it was not always easy to invest the annual budget of CHF200m into direct Swiss real estates since more and more foreign investors are tapping into the market.

In 2002 BVK diversified on a small scale into listed Swiss real estate shares. However, this portfolio (consisting of just four investment companies) will not be increased due to the limited free float on the market. The market value of this portfolio is CHF128m.

What was behind your decision to diversify internationally and can you give more details about your international strategy?

In 2004 BVK decided to diversify into foreign real estate investments. For this reason, BVK founded together with other Swiss pension funds the investment foundation for foreign real estate investments called AfIAA ( and made a commitment of CHF200m. After a period of around three years which it took to secure approval from the public authority sponsoring the fund, and based on the long-term strategic asset allocation 2007-11, the strategic quota for foreign real estate investments will be 4% of total assets (currently 1.2% or CHF 260m), that for Swiss real estate will be 16%.
The foreign quota is relatively small because this is a first step - whether it will be increased in the future we cannot say at this stage - the target is part of a four-year plan. Therefore, BVK signed an advisory mandate with Strategic Capital Management in Zurich at the start of this year. SCM advises BVK on strategic foreign real estate allocation and the evaluation, analysis and due diligence of potential investments in that area. The asset allocation matrix with regard to the geographical and investment focuses (core, value-added and opportunistic) for the investment period 2007-11 is shown in the table (right).

As a rule, returns from our Swiss real estate investments are between 5% and 5.5%. We are aiming for a return of around 7% (in CHF) from our foreign real estate investments.

We will review the regional allocation but will remain focused on Europe and north America for liquidity reasons.

As far as opportunistic investments are concerned we have a limited partnership with Blackstone Real Estate Partners. One reason for using the limited partnership model for opportunistic investments is the additional control it gives us. Furthermore we ensure that we are investing in quality and not in overheated markets.

As far as private equity and opportunistic investments are concerned we only work with very well established players with a very good track record. Finding good managers is not a problem; the problem is finding investments that are still looking for partners. The issue is that successful limited partnerships usually have their investors already and are not necessarily looking for new investors.

Do you have a view of direct versus unlisted versus listed (funds, securities) or closed- versus open-ended funds?

Direct investments in individual real estate or development companies are not a practical option given the resource constraints of an institutional investor and the manifold local planning, zoning, tax and property management issues that need to be addressed to make it work. In addition, there would be a need to build and maintain an international property management capability, which is not cost-effective even for a larger institution such as BVK.

Listed private equity funds or securities, in particular REITs, have gained enormously in significance over the last five years as they proliferate globally. They are a very effective way to gain exposure to an invested property portfolio, primarily for the income-oriented part of an international real estate portfolio.

Compared with core or value-added non-listed funds their obvious advantage is their better liquidity and lower transaction cost. The drawback, as with all listed instruments, however, is the premiums/discount versus net asset value that emerge as a result of market sentiment.

The correlation of listed real estate with stock market price movements is thus greater than is the case for non-listed funds that pursue a core or value-added strategy.

BVK prefers to use listed real estate as a means to building an income-oriented exposure to the real estate markets. It does this by using a multi-year implementation horizon to manage the valuation cycle that is driven by the interest rate and stock market environment. Non-listed funds are used to improve diversification in those sectors or regions where the supply of liquid REITs is not sufficient to represent our allocation strategy properly.

Looking at open- and closed-end funds, most of our investments in closed-end funds are directed towards opportunistic private equity strategies that often take the form of partnership commitments, as the opportunistic nature of such investment strategies requires a medium-term view, and the manager needs to have secure access to the funds necessary to fund transactions. Open-ended funds play a minor role in our investment strategy because of their liquidity requirements to fund redemptions. In addition, the open-ended market sector includes a large number of funds that are directed towards the retail market and thus does not display the fee structures one would expect for an institutional investment.

What is your view of the level of corporate governance in real estate investing? Is there too little - or perhaps as some managers argue - too much (ie, too many rules)? Do you have enough clarity/transparency for your investment decision-making?

The picture of the current level of corporate governance with regard to commingled real estate investment vehicles is very diverse.

We ensure that the legal terms and conditions of the real estate partnerships we invest in represent best practice. With regard to listed real estate vehicles and REITs the accounting and disclosure rules are, of course, as diverse as the stock markets they are traded in, and while there has been some improvement over the years it is still fair to say that even the net asset value assessment of REITs across different regions poses some difficulties for investors. This is a challenge for sector analysts and investors alike and in our opinion underlines the merits of an active strategy compared with a passive approach that aims to replicate an index.

With non-listed core funds both closed-end and open-ended, there have been some instances where valuations were slow to reflect a deterioration in the quality of the underlying portfolio, and we have also noticed that for some managers, the newness of institutional reporting and information requirements exposes both organisational and logistical weaknesses in a manager organisation.

Having said that, one must also acknowledge that many managers have made great progress in providing their institutional investors with the level of information and disclosure that is a prerequisite for an open dialogue and a long-term relationship.
The problem is in the valuation of the assets, and ensuring that a true and fair value is used is a goal we need  to aim for, both in the US and Europe.

You have been reported as criticising managers' big salaries and poor performance - does this also extend to real estate?

Based on the first investments which started in October 2004 with AfIAA, and SCM in March 2007, our expectations so far have been met. However, the investment horizon is too short to make any reliable statement of the overall performance yet. The fee structure of the investments reflects general market conditions and is in many cases - due to economy of scales - below them.

What role do investment consultants play in your real estate investment decisions?

BVK's in-house investment managers have a broad knowledge of the Swiss real estate market. However, with regard to foreign real estate investments, we rely on the expertise and in-depth knowledge of external advisers and professionals, such as Strategic Capital Management and AfIAA.

What are the key challenges facing BVK?

The real estate department of the Canton Zurich, which has been responsible over the last 30 years for all real estate investments both for the Canton of Zurich and BVK, will be split this September. The real estate department covering BVK's investments will be integrated with the BVK organisation. It will be the new head's duty to update the infrastructure of that organisation, recruit more personnel and  implement new management tools with regard to BVK's domestic real estate investments. The head of the department will be Stefan Schaedle, formerly director at Zurich Cantonal Bank.

Along with more and more other pension funds we use the rule of exception no. 59 which means that we can exceed the limit of 30% for foreign currency investments if we can demonstrate that the fund can bear this level of risk and still maintain its solvency.
The globalisation of many pension fund investment portfolios means the 30% rule is rather out of date. It was drawn up 20 years ago when funds were not internationally diversified in the way they are now.  We have exceeded this limit for many years - the size of our pension fund means that investing in a small country like Switzerland does not meet our investment needs.