Two pension funds - the $5.1 billion Pacific Gas and Electric Retirement Plan, San Francisco, and the $2.7 billion Milwaukee Employes Retirement System - hired consultant The Townsend Group, Cleveland, to operate as a manager of managers for real estate, combining the duties of investment management, consulting and internal staff functions.
Townsend will design and implement the funds' real estate investment strategy and will have the discretion to hire and fire managers.
The hiring portends a possible change in how pension funds invest in real estate and the structure of the companies that help them.
Other finalists in the search included The Frank Russell Co., Tacoma, Wash.; Institutional Property Consultants, San Diego; and Pension Consulting Alliance, Portland, Ore.
The manager-of-manager function gives pension funds a way to invest in real estate that they have had for several years in stocks and bonds. It also allows funds to move quickly on real estate deals.
Plus, the structure liberates the fund's investment staff from spending a disproportionate amount of time and money on real estate, which typically is just 5% of total assets.
"People are fed up with the time consumption of this asset class," said Townsend Principal Kevin Lynch, alluding to the oft-repeated lament that real estate takes up 5% of a pension fund's assets but 25% of the staff's time. "This is the solution to that."
"PG&E's approach is consistent with the trend toward corporate downsizing," said Townsend Principal Terrance Ahern. "The evolution is a natural and logical progression.
"Our revised role does not displace the real estate investment manager," said Mr. Ahern. "They, or comparable firms, will be used to buy, manage and sell real assets."
Townsend still considers itself a real estate consultant, but is balancing that with investment management and investment banking. It isn't the first real estate consultant to take on these functions, but this is, perhaps, the most broad change in direction.
The manager-of-managers function has been used sparingly in real estate. Townsend replaced Frank Russell Trust Co., the only other well-known real estate manager of managers, when it was hired by Milwaukee.
Russell was replaced because of poor performance, said Patrick Cronin, financial manager for the Milwaukee system. Townsend, Milwaukee's real estate consultant, was the only firm system trustees considered for the assignment, said Mr. Cronin.
"We are not aware of any other people doing this," said Mr. Cronin. "For us, it was a choice of continuing in real estate or not. We think there are opportunities there and that they (Townsend) are able to access them for us."
The PG&E staff apparently came to the same conclusion about Townsend, but it had a number of firms from which to choose. Respondents to its request for proposals included real estate money managers and traditional consultants, said Peter Corippo, manager-investments and benefits finance.
But the three finalists were all traditional real estate consultants, according to Mr. Corippo.
"The challenge for the consulting community was convincing us that they were ready to follow through on their traditional role of due diligence with one that asked them to exercise discretion and manage portfolios," he said.
"It is clear that this decision is one without a lot of precedent, and arguably, perhaps none," he said. "So there was not a lot of folks that could point to a track record of being a (real estate) manager of managers.
"So we had to make some judgments with respect to the players in the market," he said. "We identified at least three that were close to that level of maturity."
Mr. Corippo declined to identify other finalists.
Milwaukee chose a manager of managers because it is legally required to have an additional fiduciary layer between the system and the real estate manager, said Mr. Cronin.
PG&E opted for the structure for the same reason, but the decision was driven by a desire to break with the traditional realty investment patterns.
The pension fund wants to invest in real estate in the same manner it invests in stocks and bonds - with an investment professional that selects the companies it thinks will outperform a benchmark.
Like most pension funds, PG&E has invested in real estate through commingled fund group trusts, a private and illiquid security designed and valued by the real estate manager representing ownership in a property portfolio compiled by that manager.
"Our experience led us to conclude that this structure hadn't been optimal," said Mr. Corippo. "There was no reason to repeat that approach.
"So we were looking to introduce additional expertise without adding a real estate department for an asset class that is 10% of total assets," said Mr. Corippo. "Townsend had the best action plan for approaching the current portfolio and taking to the (staff's) objective."
PG&E has a 10% allocation to real estate; 4% of total assets are invested, said Mr. Corripo.
The bulk of the investments are in commingled funds; PG&E has assets invested with Corporate Property Investors, New York, Chicago-based LaSalle Advisors' LaSalle Street Fund, and commingled funds sponsored by TCW/Westmark Realty Advisors, Los Angeles, The RREEF Funds, San Francisco, and an apartment fund sponsored by Heitman/JMB Advisory Corp., Chicago, said Mr. Corippo.
The fund also has EII Realty Securities Inc. and ABKB/LaSalle Securities, both of Chicago, as managers of public real estate investment trusts.
Townsend's first assignment will be to review PG&E's managers and develop a strategic plan to reshape the portfolio. Mr. Corippo said he expects PG&E's real estate portfolio to be oriented to private equity investments.
Townsend is further ahead with Milwaukee's portfolio, putting the finishing touches on a $35 million multiple-manager REIT portfolio, said Mr. Lynch. He declined to identify the managers pending the return of completed contracts.
"That is 25% of the allocation, which will give them immediate exposure to real estate and gives diversity by property type and location and a current income stream," said Mr. Lynch.
Milwaukee has a 5% allocation to real estate, 1.5% of which is invested in the Frank Russell Real Estate Fund, the JMB Group Trust IV and a separate account triple net lease real estate investment with Net Lease Partners, New York, said Mr. Cronin.