From a small northwestern observatory…

Thanks to my friends at PERENEWS.com for bringing this to my attention.  It’s a fascinating story about how two funds can make subtly different choices about real estate investments and end up in two different places.

The two funds are CalPERS and CalSTRS, two of the largest pension funds in America.  For those of you not familiar with them, CalPERS is the California Public Employees Retirement System, and CalSTRS is the separate California teachers system.  As of March 31, 2012, CalPERS had $237.6 Billion under management, with $21.8 Billion (9.2%) of that in real estate.  As of May 31, 2012, (they have slightly different reporting dates) CalSTRS had $146.8 Billion under management, with $21.2 Billion (14.5%) in real estate.

Ironically, both pension funds underperformed their own targets for the year ending June 30, and yet for both of them, real estate was their best performing asset class.  Both funds have put emphasis on core, income-producing properties.  CalSTRS, however, despite having a fairly good real estate year (9.2% overall return), underperformed their real estate benchmark (the NCREIF Property Index) by a full 4.2 percentage points.  Notably, CalSTRS had a much higher return in the 2010-2011 period, enjoying a 17.5% overall real estate return.

CalPERS, on the other hand, enjoyed a 15.9% return, outperforming their goals by 3 percentage points.  This represents a much higher return than 2010-2011, when they marked a 10.2% gain, and very much a rebound from their disasterous 37.1% loss in 2009-2010.

Notably, neither fund did poorly this year — there is nothing about CalSTRS 9.2% overall return to scoff at.   But, why does CalPERS continue to trend upward while CalSTRS is underperforming?  Is there something key to this difference that we should be noting and learning?

Intriguingly, CalPERS devotes more of its attention to core properties — currently at 70% with a goal of 75%.  CalSTRS, on the other hand, is evenly split between core and opportunistic.  Also, CalPERS is underallocated to real estate and is in a position to make significant core investments, while CalSTRS is overallocated, and is trying to get from 14.5% down to 12% by selling existing opportunistic holdings, likely at a loss.  Additionally, CalPERS was aggressive in taking write-downs during the painful 2009-2010 season, but CalSTRS was not, and is thus still feeling the pain.

Finally, CalPERS was quick to move into core assets after the global financial crisis, allowing it to buy quality assets at bargain-basement prices.  CalSTRS was not so quick to move, and thus waited until cap rates compressed.

Lessons to be learned?  Obviously, in hindsight, cleaning up the messy books and moving forward was a smart thing for CalPERS to do.  It gave them the freedom to move forward and take advantage of opportunities.  Looking forward, there is clearly a sense that allocation is key.

However, the bigger picture is that two of the nation’s largest investment funds have a major committment to real estate, aiming for 10% and 12% allocations respectively.  The fund that is in the accumulation side (growing from 9% up to 10%) is the one making the most money, because it can take advantage of buying opportunities in core assets.  The fund that is selling is the underperformer, albeit probably for reasons other than just capital losses on sales.