Open-end funds now belles of the ball as investors return

Investors that pulled back from real estate after losing close to half of their portfolios' value during the market downturn are returning to the asset class through what they consider a more liquid model: the open-end fund.

The exit (or redemption) queues that accompanied the recent market meltdown, when investors sought to withdraw 25% or more of some open-end real estate funds' capital, are beginning to be replaced with entry queues.

“Talking to the managers, we've found that most have eliminated their (redemption) queues,” said Sally Haskins, senior vice president, real assets in the Chicago office of Callan Associates Inc. “Most open-end funds had exit queues and these peaked in the first quarter 2009 ... Entry queues did not start until the second quarter (of 2010).”

At their peak, the redemption requests totaled about $11 billion (total net asset value of the funds was $60 billion), according to data compiled by Callan. By the second quarter 2010, exit queues had dropped to around $3 billion.

Callan officials began to notice some funds having lines of investors wanting to invest. By the second quarter, six funds had entry queues, Ms. Haskins said. (Third-quarter data are not yet available.)

“The magnitude of the decline (in redemption requests) is stunning. By the third quarter we will see the numbers drop further.”

At least one manager, New York-based J.P. Morgan Asset Management, says its open-end funds now have lines of investors trying to get in.

“We've experienced a dramatic turnaround in client flows over the past year as investors recognized that real estate had become a strong relative value,” said Kevin Faxon, managing director and head of real estate, Americas, J.P. Morgan Asset Management in New York. “As a result, redemption queues that peaked in mid-2009 at more than $2.4 billion have disappeared — more than $2 billion in redemption requests were rescinded — and we are now working carefully to invest a sizable commitment queue.”

Among the pension funds investing in open-end real estate funds:

• The $12.1 billion State Universities Retirement System of Illinois, Champaign, made follow-on commitments of $50 million each to the UBS Trumbull Property Fund LP and the J.P. Morgan Strategic Property Fund., both open-end funds The system already had $105 million invested in the UBS fund and $120 million in the J.P. Morgan fund;

• The $6.9 billion Montana Board of Investments, Helena, invested in four core open-end funds: $43 million in American Core Realty Fund LLC, $30 million in the J.P. Morgan fund, $20 million in the UBS fund and $20 million in TIAA-CREF Asset Management Core Property Fund LP;

• The $10.1 billion Ohio Police & Fire Pension Fund, Columbus, invested $100 million in the UBS Trumbull Property Fund; and

• The $10.2 billion Arkansas Teacher Retirement System, Little Rock, added $50 million each to its investments in the UBS and J.P. Morgan funds.

Only a year earlier, pension systems were lining up to retrieve their money from some J.P. Morgan funds and the UBS Trumbull Property Fund. But then some investors had a change of heart.

In March, for instance, the $9.7 billion Illinois State Board of Investment, Chicago, rescinded its redemption request to terminate the $103 million J.P. Morgan Strategic Property Fund.

In October, the $9 billion Public School Teachers' Pension & Retirement Fund of Chicago rescinded its redemption requests to J.P. Morgan and UBS for all amounts except $25 million. At the same time, the system made a new investment in LaSalle Property Fund, a new open-end real estate fund LaSalle began raising last year.

The Oregon Investment Council, which oversees the $51.5 billion Oregon Public Employees Retirement Fund, Salem, sought a partial redemption of its investment in RREEF America II as part of a rebalancing strategy, said James Sinks, spokesman.

“It was the most liquid and best positioned to provide a rebalancing opportunity for the portfolio,” as dropping values caused the council's total portfolio to be overweight real estate, he said.

Capital was returned, but the Oregon Investment Council withdrew its request as property values began to recover. The council's investment officials are not considering open-end funds for future real estate investments, Mr. Sinks said.

Allen Smith, CEO of Prudential Real Estate Investors, Parsippany, N.J., said open-end funds are attractive to investors that get “a certain amount of comfort” because of “the perceived liquidity” they can supply.

Many of the redemption queues were the result of investors' need for cash during the financial crisis, he said, rather than a vote of no-confidence in real estate, he and Callan's Ms. Haskins said.

“If you think about where we were in the summer of 2009, we were just coming through the period where real estate was getting hit from the worst of the financial crisis,” Mr. Smith said. “There were a lot of people in crisis mode. They were working through liquidity issues.”

Many of those liquidity issues now have abated, he said.

“There's a calm in the market that did not exist 12 months ago.” He added, however: “There's still a healthy amount of uncertainty on what strategies make sense and what strategies can you execute.”

Said Ms. Haskins: “People are being reasonably picky, investing in the highest quality managers, in the highest quality assets and in the highest quality investment process ... There have been concerns related to the type of assets and the debt levels in some of the funds.”