As pension funds continue to trust service providers with more than mere management duties, asset managers are expected to perform more and have a better understanding of their clients' business than ever before.
Today, many pension funds, with an eye toward the bottom line, are streamlining their staffs and delegating the responsibility for more and more of the services they need to outside firms.
"Relationships are key," says Jeff DuFresne, vice president and senior investment manager with Atlanta-based DIHC Management Group, the American subsidiary of the Dutch Institutional Holding Co., the real estate adviser for PGGM, Holland's largest private pension fund. "When an institutional investor changes an asset manager, it is usually not bid, but rather given to a firm they have a relationship with."
Some of the funds' oldest business relationships are with asset management companies that handle the day-to-day management responsibilities at their properties. But these relationships are changing, becoming broader in scope, as the asset managers have adjusted to the evolving needs of their clients.
"The onus is on the service provider to find out what the client wants and then provide it for them," says DuFresne.
"In many cases, we are playing multiple roles for the client," says William N. Thompson, managing director in the Sacramento, Calif., office of Chicago-based LaSalle Advisors Ltd. "We are working with them in numerous service areas and product types -- office, industrial and retail, for example. And we are very proactive in offering new services."
"In today's environment, the larger managers have to be prepared to satisfy a number of needs that the client has," says Jerry Claeys, co-chairman of Chicago-based Heitman Capital Management. "Our clients are asking us to provide more services than ever before."
These services can be advisory, asset management, property acquisitions, property dispositions and research, among a variety of options.
Thompson says the research capability of the service provider is growing in importance. He says the research is provided in three areas: forecasting future demand in the product type, an analysis of the level of development in the product type and capital flows in real estate.
Thompson stresses the recent emphasis that has been placed on capital-flow data. "It is an area that we did not pay much attention to in the 1980s, but it is what's driving things now," he says.
For example, he cites the recent surge of investment in office and hotel properties. "Three years ago no one was investing in hotels and office properties," says Thompson. "A study of the flow of capital in real estate development verified that fact and underscored the potential for opportunities in that area.
"It got people thinking, `If no one is investing in hotels, then maybe we should be,"' he says. "So it gives your clients a jump on getting into markets that are about to be on the rise."
In addition to outsourcing more services, pension funds also are seeking to consolidate the number of companies with which they deal for a more efficient operation.
"That is becoming more and more a major factor," says Jim Ryan, senior vice president and portfolio manager with Atlanta-based Equitable Real Estate. "Clients tell us that they have the same portfolio with four or five asset management companies. They want to cut down on the number of managers they use so they are not replicating information."
That's a time-consuming process. "Pension funds are short of time and resources so the fewer managers they have to deal with, the easier it is for them," says Thompson.
Regardless of what services the client/service provider relationship eventually entails, it typically begins at the asset management level, says Claeys. And this involves a full understanding of the client's business and its real estate needs.
"What kind of portfolio strategy best serves these needs?" asks Thompson. "Is the client better off with investments that involve income or appreciation - ones in the public or private markets? And which is the better choice: the debt or equity side?"
Claeys calls this area "portfolio analytics." He works closely with the client to derive the risk-return objectives and develop a target pool of investment opportunities from which to choose. "We establish different targets based on what each client is looking for," Claeys says, "Do they need to acquire property, sell property, or do they need better asset management at their properties?"
"It is more of a strategic partnership or alliance than it is a vendor relationship," Thompson says.
Some companies can offer their clients help to quickly reverse the fortunes of troubled assets they have acquired. "Heitman has a special projects group that is involved in the quick turnaround of distressed properties for improvement or to sell them," Claeys says.
Equitable has two subsidiaries, COMPASS Management and Leasing and COMPASS Retail, which serve the same function for Equitable assets as well as third-party firms.
Diversification is a key element of the investment strategy, and it involves three areas: geography, property type and the dollar amount of the investment. They look at different cities and the local economies of each and mix and match the investments to protect their clients from downturns in one area of the economy.
For example, Claeys says an investment in the Silicon Valley in San Francisco will act similar to an investment along the I-128 corridor in Boston. Although this represents geographic diversity, on an economic level they are too similar and would be subject to the same negatives, leaving the investor vulnerable.
"Every client is different," says Claeys. "So it is important that you are flexible in the choices that you can offer them."
Discretionary vs. non-discretionary
One important choice is between discretionary and non-discretionary investment funds. Discretionary accounts are where the institutional investor gives more of the management responsibility over to the service provider, as with comingled funds where money from two or more investors is pooled to make investments. With non-discretionary accounts, the service provider is more subject to the decisions of the investor as with separate accounts, which usually involve only one client.
This decision is often dependent on the size of the client's management staff. "Many pension funds are cutting back so they require more services from us, and this usually leads them to discretionary accounts," Claeys says. However, larger firms usually prefer non-discretionary accounts, because they have the personnel to exercise more control.
"I think the trend is more toward discretionary funds, because it simplifies transactions," says Ryan. "Sellers prefer working with discretionary accounts. There is a higher degree of certainty that the sale will close, because there is not a second approval process to go through."
Also, discretionary accounts place all of the responsibility for the success of the fund on the service provider. "If the investment is not performing as planned, the pension fund's officers know who to blame," Ryan says.
The client's size is also a factor in the financial reporting. "It is important that the service provider be able to provide reports in the form that is most convenient for the client," says Claeys. "If the institutional investor has a small staff, they may only require a streamlined report with just the highlights, and they will only want to be included in major decisions about the property. But a client with a large staff may want you to provide a very detailed report, so they can make all of the decisions concerning the property."
Also, the service provider will often be required to make investments in technology to provide the information in a format that is convenient for the client's use.
"An institutional investor may have four or five managers they are working with," says Ryan. "If so, they will want to compare results at each property so they will need the data in the same manner. So, each manager is required to conform their reporting to that format."
"It isn't possible to have one system that does everything," says DuFresne, "but we do expect the service provider to give us the information in a manner that works for us."
The timeframes for the reporting is another variable. "Some clients will want the reports on a physical-year basis, others on a calendar-year basis," says Ryan.
In addition to the normal financial reports, some clients require individual reports on unexpected or unusually large expenditures, called "variance reports", says Ryan. Institutional investors have varying standards as to what level of expenditure requires a variance report. "There are going to be variances, but you have to be able to determine where the breakpoint is and make sure the client is informed," Ryan says.
"We look to the asset manager to quantify how the property will perform," says DuFresne. "Nobody likes surprises but, if there is one, we want to find out about it and get it explained as soon as possible."
The relationship of asset manager to owner has become much broader in recent years as the type of services provided have continued to expand. Developing their clients' investment strategy requires a great deal of knowledge about the clients' business, so much so that the relationship has become more of an alliance than a mere business transaction.
"I think these partnerships or alliances are the wave of the future," says Thompson. "We find that we add the most value for our clients when we have multiple relationships with them."