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April 04, 2005 01:00 AM

Performance not up to par for one CIO

Christine Williamson
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    Not all CIOs are happy with the performance of their alternative investments.

    Staff and trustees of the $11 billion Illinois State Board of Investment, Chicago, are strongly committed to alternatives in general but are being forced into an real estate extreme makeover, said William Atwood, executive director.

    In February 2004, as part of an overall revamp of the non-traditional investments in the portfolio, trustees of ISBI increased the target real estate allocation to 10% from 8%, dropped private equity to 5% from 8%, and added a 5% hedge fund-of-funds allocation. The ISBI board will vote on final funding recommendations in May.

    ISBI's real estate portfolio "has been an absolute mess over the last 10 years, but the board and I are confident that we have identified the problem and can correct it. I have confidence in real estate as an asset class and the returns we can get, but we have to restructure the portfolio," Mr. Atwood said.

    The problem has been portfolio construction, Mr. Atwood said. Assets in the ISBI real estate portfolio have been evenly divided among core, opportunistic and value-added real estate. The NCREIF Property index, by comparison, is weighted about 10% to opportunistic, 20% to value-added and 70% to core properties, Mr. Atwood said, and the difference is obvious from the performance of the ISBI portfolio. ISBI's 6.2% real estate return for the five years ended Dec. 31 was 350 basis points below the 9.7% return of the plan's NCREIF Property index benchmark for the same period.

    The overweighting in opportunistic and value-added real estate meant "when the market dipped in 2000, our real estate portfolio went with it," Mr. Atwood said. ISBI officials are restructuring the portfolio to "be negatively correlated to the overall economy so that when stocks go down, real estate will hold its own," Mr. Atwood said. "Opportunistic real estate relies heavily on asset appreciation. You might as well be invested in stocks." Core real estate such as highly credited, fully leased office properties tend to hold their value even in bad economic times, Mr. Atwood said.

    As part of its portfolio restructuring, fund officials are shifting away from opportunistic real estate to a core-oriented portfolio, Mr. Atwood said. They will use separate accounts rather than commingled funds to save on fees.

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