Doing real estate deals is fun and exciting, Paul Mouchakkaa, managing investment director for real assets at the $311 billion California Public Employees’ Retirement System, told the PERE Global Investor Forum: Los Angeles last month. The trouble is, he is not able to get as many done as he would like. In an engrossing question and answer session with Christy Fields, managing director at capital advisory firm Pension Consulting Alliance, Mouchakkaa revealed how only a fraction of the capital committed to real estate investment managers is finding its way into the market as high prices and an increasing competition, coupled with a reluctance to assume more risk or expand on its trusted strategies is hampering their deployment. Here is an abridged version of their conversation:
Christy Fields: What’s the role of real assets at CalPERS?
Paul Mouchakkaa: For real assets, it’s a few key elements, including stable cash yield, diversification of equity risk and some element of inflation protection. About half of the composite portfolio today is in global equities or stocks, and given that large exposure, the portfolio I’m responsible for implementing for CalPERS looks to seek to diversify the volatility in that portfolio.
That includes real estate, infrastructure and forestland. Real estate is about 85 percent of our exposure across those assets. Our target is to be around 75-80 percent core. In addition, the business model we implement is more centered on joint ventures and separately managed accounts with specialists in certain areas.
CF: Can you talk a bit more about the business model and what your most successful manager relationships look like?
PM: CalPERS does a lot of the front-end work to try to determine what is the appropriate strategy and sector that we want to focus on. That might be grocery-anchored shopping centers throughout the US, or it might be CBD office buildings, as examples.
The next stage is to identify who will be an appropriate partner to join forces together and execute that strategy. The things we look for are to build a relationship with that partner that’s long-term and is aligned. That term gets thrown around a lot. For us, alignment boils down to cultural alignment: they understand the objectives of CalPERS and what role real assets plays, and they’re willing to execute that strategy for CalPERS.
Second is strategic alignment, meaning whatever strategy we’re trying to employ is their area of expertise. Last is there must be economic alignment. We held a roundtable a couple of weeks ago and the question of economic alignment came up. One of our advisors said, ‘Alignment means if CalPERS makes money, we make money. If CalPERS loses money, we lose money.’ I thought that was an easy, sound philosophy.
The last thing I’ll say is we want to focus on strategies that we know we can scale over time. We tend to actually invest in a very different format through our separate accounts. They’re not a fixed allocation at one point in time; we actually allocate on an annual investment basis through our annual plan. That gives our partners, we believe, some flexibility to go and achieve what they need to do in the market, and allows us to have greater control in terms of how much money we’re committing at one point in time.
CF: You mentioned that you’re focused on strategies in which you can achieve scale. Does that tie into a manager count or trying to create fewer, larger partnerships?
PM: About a year and a half ago, we began a five-year strategic implementation plan across the whole investment office called CalPERS’ Vision 2020. The overall vision of that strategy is quite simple, to reduce complexity and execute in a much more risk-aware manner for CalPERS. Part of that vision is to try to simplify and take the risks in our portfolio where we have better understanding, experience and conviction around those investments.
We want to avoid ‘hobbies’ and focus on strategies that are repeatable, predictable and scalable. In some ways, CalPERS’ scale can be a disadvantage, and it can be an advantage. We want to play to our scale as an advantage; to chase a specific strategy that doesn’t move the needle for us isn’t one we’ll likely focus on going forward.
CF: On a related note, your own group is quite diverse. What is the role of diversity in real assets? How do you support that?
PM: Diversity is sorely lacking in the investment industry. Real estate, in particular, is getting a little bit better. In looking at my group, we have a very diverse group of management-level people. That didn’t come easily. That meant rolling up our sleeves and identifying people. Always first and foremost, we’re trying to hire the person who’s best and most aligned for the job.
What I’ve experienced in my time and my current position is that a very diverse group of people does expand your thinking and does open you up to things you may have never come across. We like to think of diversity as diversity of thought. With greater diversity of thought, it’s our belief that in the long run, that will drive better decision making.
CF: If a GP or manager has an idea that they think might be a good fit for you, how do they best get your attention?
PM: CalPERS is a public pension fund. Not to sound scolding, and I don’t mean it that way, but just do your homework. If you’re meeting with myself or anyone else on the team, have a look at the strategic plan. Have a look at the policy. Look at our holdings. You’re the experts transacting in the market. Is there a gap out there that might meet our needs and is aligned with our role and aligned with our strategy, and is there something that would work for CalPERS? It sets a very different tone when I go into a meeting for the first time with a manager and they’ve done their homework, versus flipping through a deck.
If you have questions, feel free to ask. It’s very refreshing. I was at a PEI event [Infrastructure Investor] just a couple weeks ago in Berlin, and I had a meeting with one manager there. I’d never met them before. They started asking questions, and it was refreshing and more enjoyable, and much more memorable than, ‘Hey, let’s just keep flipping through pages.’
Do your homework, ask questions and see where it goes from there.
CF: Given that core is so much of your focus in real assets and real estate specifically, as the core market is fully priced, is it becoming more difficult to allocate and deploy capital?
PM: It’s much more competitive and much more difficult to get money invested.
CF: During your annual investment process, you tell managers how much they have to invest. Is that where the problem is?
PM: They’ve been given a box that says ‘buy this product type in these markets with these general parameters.’ We’ll commit $500 million or whatever it is for that year, and they’ll execute that with discretion as long as it meets the guidelines within this box. Four or five years ago, if we gave them $500 million, 50 percent would be put to work. This year, it’s looking more like 25-30 percent. Prices are moving up. What does that mean for us? It’s much tighter and a more competitive situation.
What do you do about it? You could do nothing, which is the easy one. The second thing we could do is you could move up the risk curve. We could tell our partners, ‘We could relax this requirement or that requirement.’
Another one we could pull is we can move leverage around – we can lower it, we can raise it. The third one is to take a hard look at our required returns. The required return for real estate is 7 percent across our fund. We could work with our asset allocation group to adjust that for a period of time. Because our fiscal year ends on June 30, to get our partners ready for a new round of commitments July 1, we’re in the throes of doing all that heavy lifting and work, and communicating the best we can with our partners and getting their insight and input along the way on how to better position us for investment while maintaining discipline or focus on our strategy.
CF: If you were in a predicting mood, what’s the biggest risk for most investors in the real estate space?
PM: It doesn’t feel like we’re oversupplied, like 1990. It doesn’t feel like we’re way over-leveraged. It doesn’t feel like it’ll be 2000, like we’ll have a dot-com issue where one industry is driving everything. It’s likely to be something different. I think disruption and technological change could be a significant risk, but it’s a slow-moving risk just like demographic change – it’s a slower-moving animal.
If you asked 100 CIOs about where you would put your incremental money, at least 50 percent would pick real estate. That’s my guess. That relative trade exists today, but private real estate is not a liquid asset, meaning if that trade changes in a year from now, it’s not a good move. Really, that relative trade needs to be not one that’s good for now, but one that’s good for three or four years. If I had to hazard a guess on what is the biggest risk, it doesn’t feel like it’s supply; broadly speaking, it doesn’t feel like crazy leverage or we’re doing anything crazy over here on the risk curve. It feels like if that relative trade moves and something becomes more attractive, real estate may fall out of favor. There could be a re-weighting of that value over time.
CF: How do you think about leadership? Are there any specific principles that guide the way you manage?
PM: If I had to pick principles that matter to CalPERS, it’s that there’s an understanding and a belief across the board that everyone’s rowing the boat in the same direction. Investments are fun, they’re exciting. You get to make all these predictions. They also bring out in us as humans our passion.
If you’re not passionate about what we’re doing now, you should probably think about [doing] something else. Bringing out that passion can bring some conviction on various things. You have to stimulate that conviction and ultimately that has to go in one direction. Everyone understanding the direction and pulling in the same direction and believing in it at the end of the day is something that matters to me. It takes building consensus.
The second thing is being self-aware is an important leadership principle, not to be overly critical of yourself and trying to understand where your shortcomings are and stay grounded in what you’re doing. In particular, I think communication is important. There are so many vectors in our universe of CalPERS. We have our partners, our board, our consultants. We have a lot of stakeholders across our beneficiaries. Communication is important in whatever we do. I really value the people on my team. We may not always agree 100 percent on everything. But generally, caring for the team and their well-being is an important thing. I think that spurs loyalty and creates a better teamwork environment.
CF: What do you envision the next price correction might be?
PM: There’s been some correction in certain facets of the real estate market already: Luxury residential, B malls or C malls, though some, not all. There’s certain pockets in the real estate market that are experiencing some turbulence. I’m not sure that this price correction in real estate is going to be every sector, every market like it was in 2008-09. It might be certain pockets, certain segments. To use a stock analogy, it’s a stock-pickers’ market. If you focus on the areas that will continue or sustain through any turbulence, you’ll be better off than if you don’t pick the right ones. Perhaps the next one might not be everything going down – it might be some parts going down and other parts just being okay.
CF: What tools do you use to assess risk and how you might de-risk your portfolio?
PM: For us, we’re still in the throes of deciding what we’ll do for the next fiscal year. For me, that would be not to try anything that I don’t understand or I haven’t tried before. I don’t think it’s the time to say, ‘Let’s go try this.’
For me, I think the philosophy will be to stick to what’s tried and true, and what you know and what you understand. If that’s something that’s exciting and different, great. I think that for us is an important philosophy and approach. This year is not the time to reach for something different.
BOX
Mouchakkaa’s leadership principles
1. Be passionate
2. Build consensus
3. Be self-aware
4. Communication is important
5. Care for your team
How much committed real estate capital is deployed
Five years ago: over 50 percent
Now: 25-30 percent
Options for investing in the current environment
a. Do nothing
b. Move up the risk curve
c. Increase leverage
d. Modify return requirements
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