PERE: What does CalPERS’ current exposure to private real estate investments in China look like? What does the pension plan need from these investments?
Ben Meng: We have about $1 billion of private real estate in China, invested over a couple of years. Although our experience has been positive, during that time, we have shifted our strategy from a total- or enhanced-return strategy to more of an income-generating, core strategy.
Does China offer the international standard core real estate to provide that over the long term? That is exactly what we are looking for and why I am in China now. We have a current income need – an amount we need to pay in benefits – and our local partner in China, ARA Asset Management, currently is working out how we can find such property while playing to our competitive advantages.
PERE: What are CalPERS competitive advantages and what are its competitive disadvantages in China?
Meng: One advantage is that we are big. We have almost $300 billion in assets under management, so we are able to write a sizable check. We also are long-term investors, so we can withstand short-term volatility. When we look at international core properties, our investment horizon tends to be a holding period of 20-plus years. Those are competitive advantages.
In terms of disadvantages, particularly in China, we have quite a few, depending on where we are competing and against whom. For example, we have been looking for A+ buildings in A+ locations, but so have the sovereign wealth funds. They can focus on the long term, basing their plays on capital appreciation, because they don’t have short-term liabilities like us.
When it comes to competing with domestic players, our dollar-based fund is at a disadvantage. When investing abroad, we take on additional risk, which means we require a risk premium. In China, there is a country risk premium and a currency risk premium to consider. On top of those things, there’s the legal system to consider. Naturally, our expected return is much higher than a domestic player.
PERE: What does this realization say about CalPERS’ mandate for ARA to source core real estate in China?
Meng: In ARA, we have a very good manager on the ground, but recently we have come to realize that we probably have given them too hard of a mandate. We have been consistently outbid on A+ buildings in A+ locations, so now we are looking at A- buildings in A+ locations. With some capital expenditure, we can turn those into an A+ building in an A+ location. Or perhaps we can look at an A+ building in an A- location, with the hope that the A- location will grow into an A+ location 10 or 20 years later.
PERE: How did you get comfortable with ARA? What does that relationship tell us about how firms can gain CalPERS’ trust?
Meng: I will say that generally, when we look for a manager, we look for a long-proven track record with a very deep understanding of the local market. We don’t have a regional office, so we are highly dependent on our managers in terms of what we do in different countries. Also, we look for an alignment of interest. They need to understand who we are and what we are looking for. We have seen managers that have been very eager to sell us what they have – their existing products – instead of working with us to understand what we want for our long-term strategy. That is key to how we look at managers.
PERE: Are there particular property types in China that you favor?
Meng: We don’t look at things by property type but by the opportunity on a deal-by-deal basis. We constantly are analyzing our competitive advantages and our competitive disadvantages, as well as our competitors. Then, we look at whether the deal fits within our long-term, cash-generating mandate.
PERE: Logistics is a popular property type in China for large institutional investors, but is CalPERS a little late to that
particular party? It seems the major players’ pipelines already are spoken for?
Meng: You mention our peers as competitors, but I view them as peers. We are interested in partnering with them, perhaps in club deals. Why compete with each other when we can do deals together? We can negotiate better given the size of our collective pools of capital. There’s an English saying: “If I can’t beat you, I’ll join you.”