CALPERS Commercial Real Estate Strategy Led to Large Loss in 2009

By Arleen Jacobius
Pensions & Investment Age

Behind CalPERS' staggering real estate losses lies a strategy that took on too much risk and lacked adequate oversight.

Once the fund's star asset class, the real estate portfolio of the $201.1 billion California Public Employees' Retirement System lost nearly half its value during the one-year period ended Sept. 30. The fund's real estate consultant, Pension Consulting Alliance Inc., predicts losses will continue for at least another year.

At the heart of the problem is a freewheeling approach that took on massive leverage, gave enormous discretion to staff and experienced poor timing with its investments.

The decision-making process and risk management need to be much more rigorous, acknowledged Joseph A. Dear, who joined CalPERS as chief investment officer earlier this year. The control over leverage was not as robust as it needs to be, he added. The system will focus more on income-producing, less risky core investments in the future, he said.

“We're inclined toward investment vehicles where we have control,” Mr. Dear said. “This does not rule out fund investing,” he added.

“Hindsight suggests that a large number of CalPERS' real estate investments were extraordinarily ill-timed and inadequately underwritten,” said Stuart Gabriel, professor of finance and director, UCLA Ziman Center for Real Estate in Los Angeles. Mr. Gabriel is not connected with CalPERS.

In recognition of the portfolio's problems, the CalPERS board has imposed new limits on staff's independent investment authority, system officials are revamping its $13.5 billion portfolio and they might ax some of the fund's roughly 70 external real estate managers. (Already, MacFarlane Partners has resigned its account after a nearly $1 billion failed land deal.)
What went wrong?

Just more than two years ago, CalPERS' real estate portfolio was valued at $20.1 billion and staff estimated it would grow to $30 billion over the next five years.

What went awry? In the first half of this decade, when the real estate market was soaring, CalPERS began selling off its least risky, higher-income-producing core properties and shifting the portfolio emphasis to non-core, riskier investments. In particular, the system went after value-added real estate, taking on a bit more risk in the major property types, hotels, student and senior housing, and investing in opportunistic transactions, those taking on the most risk and leverage, according to CalPERS' 2007 strategic plan for real estate.

Some 61% of the portfolio now is in non-core investments as of June 30, the most current information available. So far, some of these strategies have been the worst performers. For example, the system's California Urban Real Estate portfolio lost 40.9% for the quarter and 56.7% for the year, ended June 30. Senior housing dropped 68.2% for the quarter and 71.9% for the year. Article continues at

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