CalSTRS Wringing Risk from Real Estate Portfolio

By Jon Peterson

CalSTRS, the second-largest public pension fund in the United States, is directing changes to its real-estate investment policy that will increase its exposure to more stable assets and limit its exposure to higher risks.

The California State Teachers’ Retirement System, with more than $130 billion in assets under management, has taken the first step toward approving the new plan. The board for the agency, which provides retirement, disability and survivor benefits for public school teachers and community college districts, approved a first reading Nov. 6. It is expected to take up the matter again in February.

CalSTRS had real estate holdings valued at $12.7 billion at the end of September, down from more than $20 billion in June 2008.

CalSTRS is working on the new investment policy with real estate consultant The Townsend Group. Micolyn Yalonis, who runs Townsend’s regional office in San Francisco, oversees the CalSTRS account.

The goal is to produce returns above those of the NCREIF Property Index while restraining risk to the maximum extent possible. The index is produced by the National Council of Real Estate Investment Fiduciaries, a trade association for the institutional real estate investment community. It measures a composite total rate of return on a quarterly basis for more than 6,000 properties nationwide held by tax-exempt institutional investors. In the third quarter, it fell 3.3 percent.

CalSTRS’ new real estate policy creates a higher floor for so-called “core” real estate investment, raising it from 30 percent of assets today to no less than 35 percent. Core real estate is the least risky with minimum vacancy, high-quality tenants and properties and predictable cash flow.

At the same time, CalSTRS is limiting its holdings of higher-risk commercial property to no more than 60 percent of total real estate assets. The value-add and high-return properties would make up no more than 30 percent each under the new plan. The current policy, which tolerates both risk profiles, allows as much as 70 percent of total real estate assets to be in these higher-risk categories.

The system will also pare its exposure to public real estate such as shares in publicly traded and privately held real estate investment trusts, from a maximum of 30 percent to no more than 15 percent of real estate assets. Up to this point, CalSTRS has made very minor investments in public real estate. Through the end of March, they amounted to $32.7 million. This capital is now managed by New York City’s The Fortress Group.

At the end of September, CalSTRS’ real estate assets amounted to nearly 10 percent of the $130 billion asset total. The board has set a policy to increase that to 12 percent.

CalSTRS pays benefits of more than $8 billion annually. It has acknowledged that it has a more than $20 billion funding shortfall to maintain its benefits as promised and that it will need increased state and school district contributions to make up the gap, even with investment earnings.

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