CalSTRS eyes core funds for 2010, 2011

The $132.2bn public pension is shifting its attention away from value-added and opportunistic strategies, and sets an overall benchmark for the asset class to meet: a minimum of 9.25% net of fees.

The California State Teachers Retirement System will hire new core real estate managers in the coming year as it looks to increase its allocation to core funds by some 15 percent.

The $132.2 billion US public pension is fundamentally changing its real estate investment strategy, recategorising its entire property portfolio, setting a 9.25 percent benchmark hurdle for all real estate investments and capping leverage on deals.

This fiscal year, we will conduct a search through a request for proposal for core managers, and will likely expand our current pool to add well-qualified core partners.

The California State Teachers Retirement System

Under the 2010/2011 business plan – which was unanimously approved at CalSTRS’ July investment committee meeting today – the pension said it would increase its allocation to core real estate to 50 percent, with value-added and opportunistic strategies set to account for 20 percent and 30 percent, respectively.

That represents a change from initial pension staff recommendations for allocations to core, value-added and opoprtunistic strategies of 65 percent, 15 percent and 20 percent, respectively.

CalSTRS has traditionally allocated its real estate investments according to core and tactical strategies, with core accounting for roughly 35 percent of the real estate portfolio and tactical (value-added and opportunistic) accounting for around 65 percent of the asset class, as of the end of September 2009.

The allocation changes will be introduced over the next three to five years. The pension said it would also look to increase its exposure to international real estate deals and funds increasing its allocation to international markets from 18 percent to up to 30 percent.

The pension said in board agenda materials that a “key source” of its increased core exposure would come from the “stabilisation of assets [in terms of occupancy and leverage] that currently reside within our value-add and opportunistic buckets”. However, investment staff added that in the fiscal year 2010-2011 the pension would “search” for core managers and “likely expand our current pool to add well-qualified core partners”.

Preference will be given to opportunities where leverage is a tool for diversification and risk mitigation rather than the primary tool for generating returns.

CalSTRS massively stepped up its investment in real estate value-added and opportunistic funds from 2005, exactly when the global property markets were starting to peak. That gearing up in activity would “disproportionately impact portfolio performance for the foreseeable future”, according to a CalSTRS' semi-annual performance review presented in April by consultant The Townsend Group.

Despite the increased focus on core, though, CalSTRS has called for the $13 billion real estate portfolio to achieve an overall return of 9.25 percent net of fees in future years.

Core will be expected to return between 7 percent and 9 percent net; while value-added investments should generate between 8 percent and 12 percent net returns and opportunistic investments in excess of 15 percent net returns. Previously, core was expected to return a minimum IRR of 5 percent net of fees, with tactical investments returning a minimum IRR of 9 percent net.

Leverage will also be capped according to strategy, with core deals limits to 50 percent loan-to-value per asset or relationship and value-added and opportunistic strategies limited to 65 percent and 75 percent, respectively.

“The use of leverage will be judicious,” investment staff said in committee meeting notes in June, when the business plan had its third reading. “Preference will be given to opportunities where leverage is a tool for diversification and risk mitigation rather than the primary tool for generating returns.”