SACRAMENTO, Calif. - A new California Public Employees' Retirement System investment strategy that requires real estate managers to dedicate some personnel exclusively to the fund has some money managers worried.
And because the strategy calls for reducing core managers to six or eight from the fund's current 15, a massive reallocation of assets among managers is probable.
Also, one pension fund official said the strategy is likely to worry the staffs of other pension plans over potential adviser bias for CalPERS in property selection.
Trustees unanimously approved the revolutionary real estate investment strategy Dec. 16 for the $104 billion fund's $4.2 billion core real estate portfolio.
But trustees at an earlier real estate subcommittee meeting split 4-3 on the vote, and some tried to stall adoption by the full board.
Issues surrounding the strategy include concerns over co-investment, control of real estate personnel, and how choice properties get divided among pension funds.
The plan is the design of David Gilbert, the fund's senior real estate investment officer. Mr. Gilbert wants to build what he calls investment teams for CalPERS. That would be a break from the typical real estate adviser structure of complete control over its own personnel.
In the typical real estate firm, personnel work for many different pension funds and on several portfolios and properties types in different geographic regions - all at the same time. Under Mr. Gilbert's plan, some personnel would be dedicated solely to CalPERS, invest in limited geographic regions and work on one or only a few property types.
As Mr. Gilbert describes it, the teams would have a hybrid structure of the real estate adviser and a real estate operating company.
By using a hybrid, Mr. Gilbert said he would get the comprehensive real estate research offered by an adviser and the focus of an operating company. The property acquisition function also will remain with the adviser.
The team structure, co-investment and incentive fees all will work to align the interests of CalPERS and its advisers, Mr. Gilbert believes.
At CalPERS' request, existing real estate advisers sent in letters of comment. The letters bothered some trustees who attended the Dec. 6 subcommittee meeting.
Robert Carlson, a member of the subcommittee, sought unsuccessfully to get written responses to the letters from the CalPERS' staff and written evaluations from real estate consultants before approving Mr. Gilbert's strategy at the subcommittee meeting.
Bruce Miller, a partner with E&Y Kenneth Leventhal Inc., Los Angeles, one of CalPERS' real estate consultants, said the letters were favorable to the plan.
In response, subcommittee member Jerry Cremins said: "Lets get real. If you are looking for a job, you say nice things."
Saying Mr. Gilbert had done an "admirable job" in preparing the strategy, Charles Valdes, a subcommittee member and chairman of the investment committee, criticized fund staff for not having written responses.
Messrs. Valdes, Cremins and Carlson voted against the proposal in the subcommittee.
Managers express concerns
Among the issues and questions expressed in letters and raised by real estate investment industry observers:
*Some smaller real estate advisers will have a hard time coming up with money to co-invest with CalPERS, and that might hurt their chances for contracts with the fund. Large real estate advisers will have to co-invest huge sums.
*Some of the best talent at real estate advisory firms won't want to hitch their careers to the fate of CalPERS' real estate investment program.
*Team members who work for the advisers are likely to try to steer to CalPERS the best properties and help their own careers at the expense of other clients.
A Pensions & Investments' review of the letters found many other questions and concerns.
In his letter, Joe Versaggi, managing director at AMRESCO Advisors Inc., Boston, noted meaningful co-investment of the advisers and CalPERS would align interests. But, he said: "To the extent there is a divergence, the needs of CalPERS' co-investment partners may skew the risk profile of the CalPERS portfolio upward in order to provide an adequate return on co-investment equity," stated Mr. Versaggi.
Co-investment can align interests, but "whose capital are you representing when there is a difference of opinion on the time to sell a particular investment?" asked Dale J. Gruen, a vice president with Metric Realty, San Francisco."
Pension executive worried
One pension fund executive privately worries that advisory personnel dedicated to the huge California pension fund might shortchange the managers' other clients in how choice real estate is divided among institutional investors.
If it looks like CalPERS is getting an unfair advantage, "I'll complain and fire the adviser," said the executive, who requested anonymity. He said he is intently watching CalPERS.
Mr. Gilbert was not available to respond to questions.
Evidence that something needs to be done to improve CalPERS' real estate investment process is clear, according to staff members and its real estate consultants. Earlier this year, they looked at the real estate managers and placed four on a termination list. Real estate investment consulting for CalPERS is handled by a joint venture of Pension Consulting Alliance, Studio City, Calif., and E&Y Kenneth Leventhal.
A staff report showed that as of Dec. 31, 1995, the fund had lost more than $1 billion in unrealized value on its core real estate holdings, based on the difference CalPERS paid for a number of properties and their worth today.
Because the CalPERS proposal is so new, the real impact of its strategy will likely be seen only as it progresses.
Ron Peyton, president of the consulting firm Callan Associates, San Francisco, said he hasn't heard of a case in which personnel of a real estate manager were dedicated to one pension plan.
Gregory A. White, executive director of the Massachusetts Pensions Reserve Investment Management Board, Boston, said many pension officials are worried about how a real estate adviser allocates properties among pension clients. He said PRIM has adopted a strategy looking at new property deals of all advisers twice a year, including deals for other clients.
"We track (the deals) so we can make sure that we are getting quality deals," said Mr. White.
All Mr. Gilbert said he wants to do is provide good real estate investment performance in a market where opportunistic buys in real estate are largely over.
He has planned changes in allocations. The recommended range for office properties will drop to 25% to 40% from 30% to 50%, while the allocation to apartments will increase to 10% to 20% from 5% to 15%. Other categories will remain roughly the same.
The geographic categories will drop to four from eight, thereby giving the investment teams more discretion on where to invest.