An improved offer will be required for managers to win back investors that have lost faith in funds
The pool of investors for discretionary fund managers to fish in is not as well-stocked as it once was. The biggest fish are increasingly reluctant to join real estate funds, preferring to make direct investments alone, in joint ventures or small clubs.
This month, the board of the $229bn California Public Employees Retirement System said it will focus on separate account mandates rather than funds, after losing 42% of its property portfolio’s value in the recession. It also plans to cut capital invested in overseas markets from 50% to 15%. Italian insurance group Generalli, meanwhile, has decided not to invest indirectly in property again and has disbanded its indirect team.
Many INREV reports have said that even large investors tend to go indirect when they invest overseas, but that assertion is looking shakier as each month goes by. When two of Asia’s largest pension funds, the National Pension Service of Korea and the Malaysian Employees Provident Fund, started to invest in European property last year, they took the separate account route.
Other investors – such as APG, which has €2bn to invest for Dutch pension fund ABP and Cadillac Fairview, which invests for Canadian pension fund Ontario Teachers – do not rule out funds. But their experiences in the past three or four years of poor performance, managers’ misalignment of interests and lack of control when things went wrong leads them to prefer joint ventures and clubs.
Cadillac’s senior vice-president of investments, Louie DiNunzio, said recently: “Our strategy is to invest side by side with an owner/operator. Their interests are going to be completely aligned with ours because they are not only a manager but they are half owner in the building.”
It is one thing to express a preference, but another to get what you want, says Simon Redman, Invesco Real Estate’s head of product management, Europe. His job is to develop new products and Invesco is one of a select group of managers that raised more money than they first expected to last year.
“It’s a question of aspiration versus practicality,” he says. “It’s easy to say ‘I’ll do club deals’, but it’s very hard to deliver. Putting any deal together now is difficult; doing one with more than one investor is very difficult. It would have to be off-market deals, as you need flexibility from the sellers, and deals that are pretty big and inaccessible to most investors.”
Providing different structures
But Redman acknowledges that if some investors want different capital structures, it is a manager’s job to try to provide them. Invesco struck its first European club deal last year: a €218m portfolio of 10 shopping centres in western Germany bought for a club of seven French clients of its French investment management partner, Ciloger.
He says: “The key thing is to be flexible. Our job is not to put square pegs in round holes, it is like a venn diagram, with investor aspirations overlapping with what the market will provide and with our capabilities. We shouldn’t over-promise; if we don’t think investor aspirations can be met we have turned down mandate opportunities.”
Laurent Luccioni, MGPA’s chief executive officer for Europe, says that following the financial crisis, investors have broader and more complex geographic and sector requirements. “Our business has focused on managing funds, but now managers need to diversify their offering,” he argues.
“Before the crisis, demand was more monolithic; now there is so much differentiation. The opportunity for firms like us is to respond to that. The classic response is more segregated accounts. Another is joint ventures or co-investment, where investors identify specific assets. The other thing is to raise focused funds, such as by country rather than diversified, pan-European funds.”
Strong pan-European managers should be best placed to find ways to tap the growing pool of unallocated, non-discretionary and demanding capital. But, says Redman, “you cannot run a whole business on it”. Managers will need to balance big teams with recurring income from discretionary funds.
Canada’s Brookfield Asset Management blazed the trail in 2009, raising $5.5bn from a club of investors to seek opportunistic deals globally. But unlike the discredited global funds raised by the large investment banks in the boom, there are no fees on committed capital for the six investors in Brookfield’s ‘Turnaround Consortium’ and each can choose whether to take part in deals.
European managers have also explored this option. Albert Yang, Henderson Global Investors’ director of institutional business, says: “We have looked at this and one or two investors have asked us to do something similar. Brookfield’s is a club of non- discretionary capital with a short-term decision-making process. That’s hard to structure and one risk is that you may not find deals to suit all the investors.”
Rob Wilkinson, AEW Europe’s head of European fund management and separate accounts, says AEW has considered a fund for large investors on a non-discretionary basis targeting large European deals, as “there’s more thin air in this space”.
He adds: “We often find large core deals and would have to manage three things: the deal, the arrangement between partners and the vehicle. We could form an umbrella structure so we don’t have to worry about the latter two, and the structure would appeal to some of the largest investors who don’t really want to do funds any more.”
Separate mandates have been part of Henderson’s business for years, but last year a single deal for one joint-venture mandate accounted for about half of its total capital spent: the £870m acquisition of 50% of Westfield’s Stratford shopping centre in east London for APG and Canada Pension Plan.
“APG and CPPIB originated the deal, then required an investment manager to advise on underwriting it, co-ordinating the due diligence and setting up a corporate governance and structure through which they could own the stake,” says Henderson director Myles White, who manages the joint venture. “They are large organisations who joined together and need a manager to manage the venture with them. We pitched for the role and won it.”
Less capital to spend
Managers don’t expect their third-party fund businesses to shrink, however, despite the big drop in fund launches, the tough capital raising environment and mixed signals in early 2011. So far this year, anecdotal UK evidence is that fund-of- fund managers and consultants have less capital than they did this time last year.
Redman counters that the gross value of Invesco’s new, open-ended, pan-European fund has risen from €62m last year to €460m now and money is still coming in. Invesco also hopes to reach a first closing for its second hotel fund in the second half of this year, after completing the first, 2006-vintage fund’s investment programme in January – but not with the same investors.
AEW Europe also plans to launch an open-ended, pan-European fund this year. “People will start to commit to funds this year, from the US and Asia as well as Europe,” Wilkinson believes. “It will be relatively spread across strategies and some will want sectors and some more diversified exposure.” This, he hopes, will include more capital for value-added strategies – “which is the part that has been stuck”.
There is an argument that investors have put less into funds because fewer have been launched – and some have been the wrong kind. Preqin’s investor survey late last year (see below) found that “a significant proportion of funds in the market are not well-positioned to succeed. Investors thought funds using strategies that were suited to the current market were difficult to locate.”
Some managers still have ambitious targets (see ‘Largest Europe-focused funds in the market’ table), while others are also raising capital, including Tristan Capital Partners, Europa-Feldberg and MGPA. “People thought things would get better last year, but I think that was too soon,” Wilkinson sums up.
Fund growth withers as investors cut the flow of capital
The number of new funds has fallen precipitously since the 2007 peak. According to data collector Preqin, only 21 UK and European funds had a final close in 2010, raising a total €2.7bn of capital (see ‘Europe- focused fund-raising’ chart). This means they were not only fewer in number, but smaller. In 2007, Preqin logged 92 final closes, which raised €20.5bn.
Partly because of the huge fall in equity going into new funds, DTZ’s most recent Great Wall of Money report last October, looking at expected investment in 2011, cut its estimate of third-party managed funds’ share of available capital from over three-quarters (77%) to half (49%). However, this is global capital and also takes account of strong growth in new capital from public and private property companies (see chart, ‘Available capital by investor type’).
Preqin also found a far from rosy outlook for fund-raising in 2011. Last November and December, the firm surveyed 100 institutional investors from around the world. It found that while 59% of European investor respondents said they were below target in real estate, 65% were “unlikely to commit” to funds this year. Of the remainder, 5% were undecided and 30% said they were likely to commit (see ‘Investors’ allocations’ and ‘2011 intentions’ charts below).
This 30% may also be higher than the outcome, judging by the previous year’s survey, when 45% said they planned to make new fund commitments in 2010, but only 37% did so. “Unlike in previous years, under-allocation to property is no longer coercing investors into making further commitments to real estate in the short-term,” Preqin says.
Funds with a 2008 vintage prove tough for the market to swallow
While the number of new launches has fallen and fund raising remains difficult, there is still a lot of uninvested equity targeted at the European market from managers that raised capital in 2008 (see table). Most are opportunistic, closed-end funds, with a typical eight-year life and four-year investment period.
Their success at deploying capital varies. MGPA says its Europe Fund III is 80% invested. EPISO, managed by AEW and Tristan Capital Partners, is 70% committed, but Heitman IV is only 20% invested. Limited partners may extend investment periods if they feel managers can justify having not invested capital, but some of the ‘dry powder’ may never be spent.
At the IPD/IPF conference last November, Nick Cooper, a principal of consultant Townsend Group, said €9bn had been raised by eight funds in 2008, of which €7.5bn was unspent in Q3 2010. “That is strange at a time when you’d expect managers to take advantage of counter-cyclical dislocation.”