California public pension fund to reduce real estate exposure

The California Public Employees Retirement System (Calpers), which is the largest US pension fund, has announced plans to reduce its real estate exposure by up to $3 billion. This move is part of an ongoing cost reduction programme which will see the pension fund reduce the number of outside advisers from 200 down to 100 by 2020. So, why has the pension fund decided to reduce its real estate exposure?

Enormous real estate exposure

The overall fund is valued at $303 billion with around $25.5 billion invested in real estate. The proposed $3 billion reduction will not include any residential properties and will either be sold as a lump sum or split up into smaller packages. It is believed that the funds raised will eventually be reinvested back into the real estate market although it is worth noting that the funds exposure to real estate will remain well below the 10% target.

Why reduce real estate exposure now?

The simple fact is that back in 2010 the pension fund took a significant hit on real estate assets to the tune of 37%. At this moment in time the fund has a target return of 7.5% per annum although due to volatile markets this has not been achieved in recent times. When you take into account the enormous amount of money invested in US real estate, although relatively small by market size, it does make sense to sell fully valued assets when there are buyers a plenty.

Short to medium-term outlook

The fund will still have real estate assets worth in excess of $20 billion even after the planned reduction with an additional $3 billion to invest in the right real estate deals. The fact that the 7.5% annual target has not been reached of late, with any shortfall made up from the public purse, has led to the fund trustees looking to reduce overall costs. A reduction in running costs, a more focused approach to outside managers and a less complicated investment profile should improve investment returns in the longer term.

The US real estate market is attracting the attention of domestic and overseas investors and many experts believe the fund will have little difficulty in offloading assets up to a value of $3 billion. The US economy is not exactly firing on all cylinders but it does seem well-positioned for medium to long-term growth even if the short-term outlook is mixed to volatile.

Will other investors follow suit?

There may be others who will follow the path of Calpers although in reality there seems to be a mood of positivity running through the US real estate market at the moment. Whether this is the right time to reduce real estate holdings remains to be seen. However, the fund is worth in excess of $300 billion including real estate assets currently valued at around $25.5 billion (around 1% of fund value) so is it really a major shift in investment strategy?

It will be interesting to see whether the pension fund is able to dispose of these real estate assets in one transaction or whether indeed they will be broken down into smaller tranches.