SACRAMENTO, Calif. -- The California State Teachers' Retirement System has hired nine real estate managers to invest for its new low-risk "discretion in a box" strategy, said Patrick Mitchell, chief investment officer at the $99.1 billion system.
The managers will not be given precise amounts to invest, so they can focus on good ideas without being limited by dollars, he noted. The dollar amount of the program will be determined at the July 7 board meeting, but none of the managers will be told what the decision is.
In an interview, Mr. Mitchell said five of the managers are new to the system and the other four had been rehired after going through the RFP process. The existing managers will continue to use the same strategies they had been using, but with a discretion unavailable to them before.
Managers that were rehired are C.B. Richard Ellis Investors, Los Angeles; SSR Realty Advisors, White Plains, N.Y.; Lend Lease Real Estate Investments Inc., Atlanta; and MIG Realty Advisors, West Palm Beach, Fla. The new managers are Heitman Capital Management, Chicago; Lowe Enterprises Investment Management Inc., Los Angeles; Clarion Partners, New York; Sentinel Real Estate Corp., New York; and Thomas Development Partners, Los Angeles.
Mr. Mitchell said the CalSTRS' strategy is somewhat different from other pension funds because it is not specifying how much the managers can invest. "We have looked at that approach and decided not to take it, because we don't want any artificial constraints."
Frank Blaschka, principal at the Townsend Group, Cleveland, said many pension funds now use the discretion in a box strategy for part of their real estate portfolios, but usually the managers know how much money they have to invest. Generally the managers are evaluated each year, and the amount they are given the next year hinges on how they performed the previous year, he said.
CalSTRS' Mr. Mitchell said the contracts are "evergreen, and will automatically be extended each year, unless we choose to terminate them. They will be evaluated every six months."
Pension funds that have established the discretion in a box strategy with Townsend's help include Los Angeles County Employees Retirement Association, and the pension funds for the states of Iowa, New Hampshire and Massachusetts, Mr. Blaschka said.
The system has a 5% allocation to real estate, but only 2.5% of assets are invested. The new program is all low-risk and will make up around 75% of the real estate portfolio. "We like low-risk properties that can offer a high rate of return from cash flow. They're also a good way to diversify," Mr. Mitchell noted.
Objectives for the system's high-risk real estate strategy will be presented at the upcoming board meeting. These include investments in urban redevelopment and single-family and multifamily housing, and others that are in the works, Mr. Mitchell said. The system will not issue RFPs for manager for the high-risk strategies, but will select managers for single strategies, and the managers will need fund approval before investing in specific deals.
Freedom within bounds
CalSTRS' "box" has set parameters that will be monitored by Mitch Pleis, the system's director of real estate investments: Investments must provide cash flow of at least 8% after fees (a number that will change regularly, depending upon the Treasury market); internal rate of return must be at least 10%; properties must be located in the United States; and they are limited to the office, retail, industrial and apartment sectors.
Managers such as SSR and MIG that invest only in apartments will have to stick to that, Mr. Mitchell said. But managers that are diversified across several sectors will be free to buy in any sector permitted in the strategy.
Previously, the pension fund approved managers' requests to invest in properties on a case-by-case basis. Under the new plan, managers will have discretion to register the properties they plan to buy with the pension fund and then proceed to close. Transactions cannot be any larger than $100 million, and no manager can have more than $300 million in deals under registration at a time.
"If too many deals are in registration at the same time, we'll suspend registration for a while," Mr. Mitchell said.
The contracts with the nine managers in the program are in the process of being signed and should be completed by the end of July. The managers "can begin investing as soon as they have contracts," he said. Since January, the system has committed $500 million to existing real estate managers.
2 sources of funding
Funding for the real estate investments will come from two sources: the allocation to real estate that has not yet been invested and which is parked in a Standard & Poor's 500 index fund; and the $3.5 billion in free cash flow the system has built up to be used for investments in asset classes that are below target allocations. As of May 31, all of CalSTRS' asset classes are under target because U.S. equities have done so well, Mr. Mitchell noted.
"Our priorities are real estate and alternative investments, because they are the hardest to invest in," he continued. The target allocation for alternatives, like the real estate allocation, is for 5% of assets, but only 2.5% is invested.
U.S. fixed-income investments now stand at 25.8% of assets, just short of the target 26% allocation, and international equities stand at 23.3%, shy of the 25% target. U.S. equities, meanwhile, stand at 45.6%, well above the target of 38%.