Trustees of the $93 billion California Public Employees' Retirement System will meet this week to consider three consultant reports that recommend terminating poorly performing managers.
The reports also criticized the structure of the real estate investment program and recommend substantial changes.
If the trustees follow the recommendations of the consultants, LaSalle Advisors Ltd. and Equitable Real Estate Investment Management, each of which manages more than $1 billion (book value) of real estate for the fund, could be terminated or have their mandates significantly reduced. They are two of the fund's largest managers and worst performers.
Such a decision could be devastating to Chicago-based LaSalle and Atlanta-based Equitable Real Estate, because the California fund is the single-largest domestic pension fund client of both.
California Employees' has 17 real estate managers. The Sacramento-based pension fund divides them between direct property managers, indirect managers, sector advisers and apartment advisers. LaSalle and Equitable are direct property managers.
Sheryl Pressler, chief investment officer, declined to comment on the recommendations, said Patricia Macht, a spokeswoman. Telephone calls to some of the system's trustees were not returned.
Pensions & Investments obtained copies of three consultants' reports that concluded poor performing managers should be terminated and that Equitable's and LaSalle's performance had been among the pension fund's worst over the long term.
(The system's worst real estate investment was the purchase of the Canadian property company Cadillac Fairview, made in 1987 by JMB Institutional Realty. The deal remains on the retirement system's books because the system retains an equity position, but JMB is no longer a manager for the fund. Heitman Advisory Corp. acquired JMB last year.)
The three reports - one done by Buzz McCoy Associates Inc./Milestone Partners Ltd. and two by Pension Consulting Alliance Inc./Kenneth Leventhal & Co. - were presented to the board in closed session at various times between December 1994 and January 1996.
According to the reports, Equitable underperformed the NCREIF Property Index for the one- and three-year periods ended June 30, and barely beat the index for the seven-year period. LaSalle underperformed the benchmark for the three- five- and seven-year periods, but it surpassed the benchmark for the 12 months.
Equitable manages a portfolio with a book value of $1.36 billion now worth $997.3 million, a 27% decline.
LaSalle's portfolio is trickier because of a merger with Alex. Brown Kleinwort Benson in 1994. The combined LaSalle/ABKB portfolio has a book value of $1.56 billion and is now worth $1.17 billion, a 25% decline. Separately, LaSalle Advisors invested $893.4 million for the fund, and that is now worth $637.2 million, a 29% drop.
ABKB performance separate from LaSalle is stronger, according to a performance attribution review completed by PCA/Leventhal.
Standards promulgated by the Association for Investment Management and Research state analysis of historical performance of merged companies should be performed and reported separately.
Other money losers for the fund are TCW/Westmark Realty Advisors, Los Angeles; Prudential Asset Management Group-Real Estate, Short Hills, N.J.; and The RREEF Funds, San Francisco. Since inception, TCW's portfolio has lost 11.5% of value; Prudential's lost 19.8%; and RREEF lost 14.4%. All returns are for the period ended Sept. 30.
But Prudential and RREEF assumed responsibilities for properties previously managed by Heitman/JMB Advisory Corp.; 74% of Prudential's losses and 65% of RREEF's losses are attributable to the previous management, said PCA/Leventhal.
TCW's absolute dollar loss is only $48 million, compared with $393.3 million for LaSalle/ABKB and $364.9 million for Equitable.
Sentinel Real Estate Corp., New York, was the only other manager to post a loss, and it was three-tenths of a percent. The other managers showed gains.
A LaSalle Advisors official said the firm had responded to the California fund on the issues raised in the reports. Lynn Thurber, co-head of LaSalle Advisors, declined to discuss the response, citing confidentiality restrictions.
"We are aware that in January, the board met in closed session to discuss the report," she said. "We don't know what recommendations they discussed.
"We are aware that further discussions are planned."
A spokesman for Equitable Real Estate said the company would have no comment.
It is not known which set of recommendations the trustees will use. PCA/Leventhal's real estate unit review and the McCoy/Milestone report both recommended manager changes, altering the internal investment decision process and restructuring the fund's real estate department.
Ms. Macht declined to say why the trustees needed a second review of its real estate department.
PCA/Leventhal's review was performed in late 1994 and presented to the board in early 1995. The report was presented in closed session but several publications obtained summaries, including P&I. The McCoy/Milestone report was presented in closed January meeting.
The PCA/Leventhal report made 13 recommendations and conclusions. Chief among them:
The real estate program has inadequate strategy or portfolio management;
Staff morale is poor;
Each participant in the investment process should be held accountable for its decisions;
The fund has too many advisory relationships; and
The fund does not receive the benefits associated with its size in the marketplace.
The fund's staff wrote a rebuttal to the report that addressed the morale issue and other conclusions.
The McCoy/Milestone report concluded that:
The real estate unit must have a tough leader who has the full support of the board and is fairly paid with a substantial portion based on performance;
The real estate subcommittee should appoint a real estate advisory council composed of three to five real estate industry leaders and experts to advise it;
The performance of all current advisers should be scrutinized, and appropriate action taken based on poor performance, including termination, redistribution of properties, no new allocations, etc.
For the three-year period ended Sept. 30, the Equitable, LaSalle and JMB portfolios constituted a drag on performance as they trailed the NCREIF Index with compound annualized returns of 1.2%, 0.4% and -67.3%, respectively, vs. 2.7%.
For the five- and seven-year periods, the LaSalle and JMB portfolios also trailed NCREIF. NCREIF returned -0.1% and 1.7%, respectively for the periods. JMB lost an annualized 53.5% and 39.5%, respectively, during the same times; LaSalle posted an annualized return of -1.2% during the five-year period and 1.3% for the seven years.
The NCREIF Index has been rising and posted a one-year return of 7.9% for the year ended Sept. 30. Both the LaSalle and LaSalle/ABKB portfolios exceeded the benchmark for the period.
