Los Angeles Fire and Police is the latest US pension to explore setting up an in-house, direct real estate investment platform. It is also the latest to find the proposition untenable.
The system’s board of commissioners directed its staff and consultants from the Townsend Group to compile reports on direct investment and what it would take to implement. According to the reports, which were presented at LAFPP’s January meeting, they found the expense of setting up such a platform to be prohibitively high.
“We’re not changing our strategy at this point,” Ray Ciranna, the fund’s general manager, said, citing the staffing demands and related expenses, which were too great for the roughly $22 billion pension fund.
The reports found that most direct investment platforms are backed by either robust in-house teams or freestanding real estate firms – such as Ivanhoé Cambridge for Caisse de dépôt et placement du Québec and Cadillac Fairview for Ontario Teachers’ Pension Plan – and pay salaries comparable with the private sector. Those expenses would wipe out the cost-benefit of avoiding management fees associated with indirect investments, Ciranna said.
“We looked at what staffing would be needed, compensation, things of that sort,” he told PERE. “We evaluated whether we could do it, whether there would be a cost advantage or not. We’re a pretty good size fund, but a lot of the folks that really have dabbled in more direct investment are considerably larger than us.”
LAFPP’s report noted that the term “direct investment” can vary from investor to investor. The report identified just one US pension that directly manages real estate assets in-house: the State Teachers’ Retirement System of Ohio. With more than 100 investment professionals – 40 of which are dedicated to its direct real estate portfolio – STRS Ohio dwarfs LAFPP, which has an investment staff of 13, three of whom focus on public equity and real estate.
In addition to staff, STRS Ohio also has significantly more capital resources. According to 2018-19 budgets, the Ohio pension has $61.8 million for salaries and $715,000 for travel, compared to $12.1 million and $147,000, respectively, for LAFPP. Also, along with its Columbus, Ohio headquarters, it has regional offices in New York, San Francisco and Atlanta, and plans to open a Chicago outpost this year.
LAFPP’s interest in pursuing direct investment arose from the growth of its separate account program, which has amassed $490 million of assets since 1989. The board wondered if it could handle those services internally, which would save the $4 million it has budgeted for management fees to the Boston-based firm AEW Capital Management, its separate accounts manager. However, Ciranna said, replicating that partnership and its nationwide exposure would require considerable staff increases.
LAFPP is not the only US pension fund drawn to direct investment in recent years. Several other institutions have launched similar exploratory campaigns, PERE understands.
“It’s about reducing fees and controlling decision making,” said Doug Weill, a founding partner at the advisory firm Hodes Weill & Associates. “Institutions increasingly desire the ability to say when they sell an asset so they can have control over liquidity.”
Nick Treneff, a spokesman for STRS Ohio, said its platform has delivered on those goals since it was established in the early 1980s. The direct portfolio has also outperformed its net profit index benchmark in 13 of the past 15 years. Cumulatively, it has beaten expectations by 338 basis points since 2003.
However, Treneff said the success of STRS Ohio’s direct investment platform would be difficult to replicate in 2019.
“STRS Ohio began its program in a different time,” he wrote in an email. “To do so today would be extremely difficult for several reasons, the most critical being the compensation constraints of most public funds.”