Leverage, Fees to Blame for US Pensions' Real Estate Doldrums

US pension funds have had the lowest real estate returns in the global pensions industry, a recent study has claimed.

(September 12, 2012) — Pension funds in the United States have suffered the most dismal real estate returns in the pension industry worldwide, according to a study by Maastricht University.

While property investments generated an average net annual return of 5.7% for US pension funds from 1990 through 2009, Canadian funds generated 7.2% returns, the study originally obtained by Bloomberg asserted. Meanwhile, the average cost of managing US pension funds’ real estate investments is 64% higher compared to Canadian funds.

The Netherlands-based university surveyed 884 funds with more than $4.6 trillion of total assets under management.

Consultants attribute the lack of real estate investment return among US-based pensions to a less conservative culture, especially prior to the financial crisis, with US investors generally farther out on the risk/return spectrum compared to Europeans, for example. “The higher you go on the risk/return spectrum, the higher the leverage, which hurt investors during the down market,” Peter Lewis, a senior investment consultant at Towers Watson, told aiCIO.

“US pensions also suffer higher costs due to less use of in-house management and more fees as a result,” Lewis said, comparing US pension to their Canadian counterparts. “Many Canadians have a culture of doing significantly more in-house, so it costs less for them to manage their portfolio.”

During the financial crisis, while US, European, and Asian investors suffered severe drawdowns, Canadians were relatively unscathed. “Compared to numerous Canadian and European investors, many US investors were more comfortable with higher yielding strategies, such as opportunistic real estate, which underperformed largely as a result of too much leverage in 2008,” Lewis said.

So how has the approach to real estate changed in the US among pensions, which have been scarred by lowly real estate returns? “For one, there’s been a change in psyche,” Lewis said, noting that US investors have become more focused on the income component to returns. “When it comes to US pensions being reluctant, the concern about potential litigation is very present — we’re an increasingly litigious society. The implication: investors are always concerned about liability.”

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