U.S. Funds Have Pension Industry’s Lowest Real Estate Returns

U.S. funds have had the lowest real estate returns in the global pensions industry because they rely on costly external managers and made risky bets before the financial crisis, according to a study by Maastricht University.

Property investments generated an average net annual return of 5.7 percent for U.S. pension funds from 1990 through 2009, according to research by the Netherlands-based university. That compares with 7.2 percent returns for Canadian funds and a typical return of more than 7 percent for other funds.

The average cost of managing U.S. pension funds’ real estate investments is 64 percent higher than for Canadian funds, which have the second-highest costs, the study showed. Just 7.6 percent of U.S. funds’ real estate assets are managed internally, which costs the least. The study surveyed 884 funds with more than $4.6 trillion of total assets under management.

“U.S. pension funds are reluctant to make in-house choices, and one of the main reasons for this is their concern about potential litigation,” said Nils Kok, a co-author of the study, in an interview in Berlin last week. He presented the report at the European Public Real Estate Association’s annual conference.

U.S. state and local government pension programs with total assets of $2.8 trillion returned 1.2 percent in fiscal 2012, according to a study released last month by Santa Monica, California-based investment adviser Wilshire Associates Inc. That’s less than the 7 percent to 8.5 percent returns needed to pay retirement benefits, leaving programs with a funding shortfall to be met by participants and through public-service cutbacks.

‘Foolish’ Choices

“Many of the pension plans are under-funded, and when these funds see an opportunity to juice up their returns, they go for it,” said Kok. “From 2004, a large number of these sophisticated investors made foolish investment choices that were no different from the exuberance of retail investors.”

In fiscal 2009, the California Public Employees’ Retirement System had a 48 percent drop in the value of its real estate portfolio, the culmination of a decade-long loosening of risk controls and large leveraged bets on housing made by external money managers before the collapse of Lehman Brothers Holdings Inc. roiled markets.

Calpers, as the U.S.’s largest public pension plan is known, has since reduced debt, fired underperforming managers and focused its investments on less risky real estate. Its property investments returned 16 percent in the 12 months ended June 30, the fund reported in July.

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