Belief systems

While many US pension plans are putting their faith in core strategies, KKR is urging them to go opportunistic

Invest more in real estate. In particular, invest more in opportunistic real estate. That’s the message New York-based alternative investment giant Kohlberg Kravis Roberts (KKR) is conveying to US institutional investors with its new research report.

The report, Real Estate: Focus on Growth, Yield and Inflation Hedging, recommends that investors increase their allocation to real estate to 5 percent of total assets from its previous recommendation of 3 percent. In addition, due to widespread deleveraging, KKR notes that “there are compelling investments in the non-core and opportunistic segments of the real estate market that can provide investors with a more attractive risk-adjusted return profile”.

Some LPs have told PERE that not only is the research sound advice, it’s far from difficult to adopt. In fact, one pension plan representative that recently made the switch to opportunistic investments said that he didn’t understand why more LPs weren’t increasing their allocations to opportunistic real estate. Since core products are becoming increasingly overpriced, it pays for LPs to make the transition from core to opportunistic.

It is true that a number of the bigger and mid-sized US pension plans already have real estate allocations between 5 percent and 10 percent, which is equal to or greater than KKR’s recommendation. Many investors, however, remember being burned by opportunistic real estate funds that failed to perform (due in part to the global financial crisis), so this message from KKR comes at a time when they are edging away from opportunistic investments and more towards stable, income-producing assets.

CalPERS and CalSTRS are two pension heavyweights that recently shifted their portfolios to target more core investments. The Los Angeles Fire and Police Pensions and the New Mexico State Investment Council also are moving towards core (though it should be noted that New Mexico contributed to Blackstone’s seventh global opportunity fund over the summer). 

In many ways, the heavy interest from pension funds in core is what makes non-core strategies more attractive. And with a current environment of deleveraging, the number of opportunities for non-core investments is rising. According to one consulting firm PERE spoke with, opportunistic has a long record of outperforming core strategies, provided investors are mindful of fees and structures.

Careful analysis of this record might persuade more investors to up the ante and eschew core. But this might not be a decision that is influenced by reason alone. One LP said the decision to invest in more real estate—particularly in opportunistic real estate—is ultimately dependent on belief systems. In a sense, KKR is explaining to investors ‘this is where we believe the value lies’. What’s making the investors decide whether or not to listen to KKR’s advice is determined by what they believe.

Those investors now ramping up their exposure to higher-risk, higher-return strategies must be hoping that not too many of their peers will do the same. As ever in markets, the irony of KKR’s creed is this: the fewer investors that convert to it now, the more successful the recommended allocation strategy will turn out to be.