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CalPERS’ Real Estate Portfolio Returns Slump

November 14, 2012
The California Public Employees Retirement System’s (CalPERS) Real assets segment could not duplicate prior quarter’s success, when it was the highest returning major asset class.

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The investment class, that primarily includes real estate, finished the third quarter with a small positive gain of 0.9%, which trailed both the total fund policy benchmark as well as its own custom policy benchmark (2.2%).

Most of this performance was driven by the real estate component, whose portfolio assets represented 87% of the real assets composite and finished the quarter with a 1.2% return.

Real assets’ remaining two components, forestland and infrastructure portfolios, both reported small losses for the quarter and also underperformed their respective policy benchmarks.

The real assets composite’s 1-year return currently remains ahead of its policy benchmark, but it continues to trail over the long-term. Performance over the 1-year period continued the upward trend started in the third quarter of 2010. The positive returns were due largely to unrealized appreciation.

Over the longer term, the real estate program had less favorable results with net returns of 5.2%, -12.6% and 2.5% during the trailing 3-, 5- and 10-year periods, respectively. These returns were less than the comparable benchmark returns of 10.4%, 4.1% and 9.1%, respectively.

The performance of the real estate portfolio has been hindered by three primary factors: significant amounts of CalPERS’ capital were invested during the 2005 to 2007 period which exposed the portfolio to the risk of vintage-year concentration; the high proportion of the portfolio invested for capital appreciation (not current income) in riskier, non-stabilized properties; and high amounts of leverage employed at the peak of the cycle.

The final two factors exacerbated historical underperformance to the benchmark during the economic crisis. Non-stabilized assets provide less income to insulate against valuation declines. Increased leverage magnifies positive appreciation returns in upward market cycles and negative appreciation returns in downward market cycles.

In February 2011, CalPERS approved a new real estate strategic emphasizing reliable current income and a diversification from public and private equity return characteristics. Since then, the portfolio has begun to shift in emphasis towards strategic, stabilized, domestic core assets held for a longer term, and away from more tactical, opportunistic, appreciation-oriented investments held for a shorter term.

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