As you may recall from prior posts, the Accordant ODCE Index Fund (ODCEX) invests side-by-side with institutional capital in the roughly two dozen open-end, diversified, core equity (ODCE) funds that comprise the NCREIF-ODCE Index. Those funds are the descendants and successors, so to speak, of a pioneering group of funds that were first formed in the late 1970s and early 1980s to facilitate investment by pension funds in private real estate.
This is the story of how those early generation funds came about and the role they played in expanding the addressable market for PRE (private real estate) capital formation efforts to public and private pension funds.
It’s hard to imagine these days that there once was a time when pension funds were not meaningfully long private real estate. However, the facts about pension fund portfolios in those days are even more startling.
As it happens, until sometime in the 1960s, most such portfolios were heavily weighted towards, if not composed entirely of, fixed income investments in the form of long-term bonds. During the ’60s, this slowly began to change as the benefits of diversification became more apparent thanks to academic research that championed modern portfolio theory as a means of managing risk. By the 1970s, institutional portfolios began to diversify into public equities to the tune of 40% on average.1
Those of us who were around in the mid-1970s have no trouble remembering how stocks and bonds performed during those years of high inflation. The S&P 500 experienced 40% nominal losses in 1973-74, and at the same time, long-term bonds had returns that were deeply in the red. (In the last few years, we have seen periods which have modestly replayed this phenomenon, where both equities and fixed income traded down in tandem thanks to the impacts of inflation and rising interest rates.)
By contrast, during the mid-1970s private real estate was booming. It enjoyed rapidly increasing values and strong demand, producing performance that easily outpaced inflation.
These events did not escape the attention of those folks who were responsible for investing pension fund capital. As we saw in a prior post, the enactment in 1974 of ERISA had freed them up to be able to consider adding alternative asset classes, such as PRE, to their portfolios.
Moreover, no investment vehicles had yet been developed that would ease their entry into the sector. Direct investment in actual physical properties themselves was not really an option, given the limits on most pension funds’ allocations to the sector (generally around 5% of their assets), if they wanted to build anything like a diversified portfolio.
This is where banks and life insurance companies came riding to their rescue, as it were. Banks and life co’s had been investing in real estate, mostly in the form of commercial mortgages, for quite some time. Some of these institutions had actually gone long PRE equity, as Met Life did when it developed the multi-family residential in Manhattan known as Stuyvesant Town and Peter Cooper Village, but even those who hadn’t gone that far had become generally conversant in and familiar with the asset class.
For example, as you may recall from a prior post, Gerry Hines developed a strong relationship with New England Mutual early in his career and relied on debt financing from them for his projects time and time again. My guess is that, in the course of this long and mutually beneficial relationship, the New England Mutual people learned quite a lot about real estate investing from my old boss and client.
Furthermore, many banks and life companies had existing relationships with state pension funds through the provision of equity or fixed income products and other services. They had a built-in base of potential clients for the investment management services that those clients so plainly needed.
With all that going for them, the banks and the life co’s did what must have seemed like the most obvious thing in the world at the time. In the late 1970s, they began to establish open-end funds which could pool the capital committed by their pension fund clients for investment in portfolios of high-quality PRE that was diversified by product type and geography. By so doing, the banks and life co’s created incremental fee streams for themselves as fund sponsors while at the same time providing to their client investors access to vehicles which, since they were open-end, could accept subscriptions for new investment periodically as well as redeem out those investors who sought to rebalance their portfolios or who just needed some liquidity.
These were among the first fund vehicles ever to aggregate sizeable amounts of institutional capital to be invested at the discretion of a sponsor-manager in PRE. The sponsors included some very familiar names, both then and, to some extent, now: John Hancock, AETNA, Cigna, Prudential, Met Life, First Chicago, Wachovia, Bank of America and Crocker Bank.
The availability of suitable investment vehicles such as these opened the floodgates for pension fund capital to enter the space, both through open-end funds and other vehicles as well.
As J. Donald Henry notes in his thesis, there were 27 pooled PRE funds at the end of 1979 with something like $4.6 billion of assets under management. By 1984, he tells us, there were 70 such vehicles with total assets under management of around $41 billion—an almost tenfold increase in five years. Of this amount, some $16.5 billion was invested in open-end funds and the balance found a home in “closed end funds, single property funds, separate accounts and direct investments,” reflecting the confidence that pension fund staff had by that time built up in their ability to discriminate among various product offerings so as to choose those that best met their investment objectives.
The recession that basically pancaked the PRE market in the late 1980s and early 1990s, that I referred to in a previous post, did not spare the performance any of these vehicles, and both their investors and their sponsors learned some very hard lessons about what a market that grinds inexorably downward for an extended period can do to returns and investor relationships. Those lessons, in turn, led to something of a reformation for the better of the investment fund landscape and business model, bringing the sector closer in those respects to where it is today, and we will come onto that subject in a later post.
1 A Case Study and Retrospective Analysis of Institutional Open-End Equity Real Estate Funds: John Hancock Equity Real Estate Account 1977–1987, J. Donald Henry (1995).
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This article reflects the personal views and experiences of the author and is provided for informational purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any product or service offered by Accordant Investments or its affiliates.
Jim Hime is an investor in the Accordant ODCE Index Fund. He receives a salary and other ordinary employment compensation from the adviser in connection with his role at the firm. He did not receive any additional or separate compensation for providing this statement. Because of his employment relationship and his personal investment in the fund, he has financial incentives to promote the fund. This statement reflects his personal views and experience and should not be considered a guarantee of future results or representative of the experience of all investors.
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An investment in the Accordant ODCE Index Fund (“ODCEX”) is suitable only for investors who can bear the risks associated with investments in the Underlying Funds and the various real estate equity and debt strategies which such Underlying Funds utilize, with potential limited liquidity. Even though the Fund makes quarterly repurchase offers for its outstanding Shares, investors should consider the Shares to be viewed as a long-term investment within a multi-asset personal portfolio and should not be viewed individually as a complete investment program.
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Investing in the Accordant ODCE Index Fund (“ODCEX”) involves risk, including the risk that you may receive little or no return on your investment or that you may lose part or all your investment. The Fund’s investment objective is to employ an indexing investment approach that seeks to track the NFI-ODCE Index on a net-of-fee basis while minimizing tracking error. There can be no assurance that the actual allocations will be effective in achieving the Fund’s investment objective or delivering positive returns. It is not possible to invest in an index.
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