CalSTRS addresses RE investment challenges

In its latest meeting materials, the pension system reported difficulties achieving its target return and expanding into strategies outside of the four main property types.

The California State Teachers’ Retirement System is analyzing how to prepare its real estate portfolio for lower returns, the pension system said in materials ahead of its Thursday meeting.

“We believe it will be a challenge to attain an 8 percent overall return especially if the US economy slows down. Beating our benchmark will also be a challenge as we are overweighting lower risk strategies,” the pension system wrote in its real estate business plan for fiscal year 2017-18. The pension system, which had 60 percent of its $25 billion property portfolio in core real estate as of March 31, predicted that capital appreciation will slow from 5-8 percent to 1-3 percent as a result of increasing supply and potentially rising interest rates.

CalSTRS’ return target for the fiscal year beginning July 1 is 7.7 percent for core and 9 percent for non-core real estate investments. Additionally, it seeks to outperform the ODCE open-end fund index by 70 basis points.

CalSTRS also addressed other difficulties with real estate investing going forward. For example, it noted that while real estate staff had “reasonable” coverage in the US in the four property types, “it is an ongoing challenge to expand these investment structures to debt investments and specialty product types like senior housing.” Meanwhile, the pension system also is considering increasing or expanding its positions in real estate operating companies, but anticipated that using similar structures outside of the US would be “challenging if and when we decide to expand international allocations.”

In the future, CalSTRS staff also plans to explore options to expand its direct investments and co-investments across asset classes. Within real estate, it determined that joint ventures, separate accounts and co-invests with closed-ended funds were the best structures for lowering fees; joint ventures, separate accounts and company ownership for increasing control; and closed-ended funds and JVs for access to dealflow.

Co-investments, joint ventures, custom accounts, and separate accounts make up 69 percent of CalSTRS’ real estate portfolio, according to meeting materials. The pension system currently invests directly – without an external fiduciary and intermediary – only in its fixed income and global equity portfolios.

In real estate, CalSTRS has $6.8 billion invested in closed-ended funds and co-investments, compared with $18.1 billion internally managed through JVs, separate accounts and open-ended funds, as of March 31.