Recent returns in Oregon Public Employees Retirement Fund’s (OPERF) $13 billion real estate portfolio are linked to a combination of factors including a strategic pivot to multi-family and industrial exposure and the growth and performance in the fund’s boosted allocation to separately-managed accounts which have improved alignment and allowed significant fee savings.
The portfolio’s performance is also attributable to its large allocation to core, income-driven real estate at a time of sustained, strong core performance. OPERF’s predominantly core allocation means investments are at the lower end of the risk spectrum with a focus on high quality, lower leverage, relatively liquid assets in established markets.
A strategy that dates from 2016 when the investment team began to gradually de-risk the allocation, liquidating opportunistic investments in favour of more sustainable, long-term portfolio and reduce embedded risk.
“We have achieved outperformance without taking outsized risk,” said Christopher Ebersole, investment officer, real estate, at Oregon State Treasury which invests Oregon’s state funds including the $95.4 billion OPERF portfolio, speaking in a recent council meeting.
For the period ending September 2022 the portfolio returned 20.54 per cent earning a 10 year return of 11.21 per cent. The real estate portfolio has generated $2.4 billion in net cash flows since 2010.
Still, looking ahead, Ebersole flagged that the allocation will be increasingly buffeted by higher financing costs and challenges around price discovery characterised by sizeable bid ask spreads in most transactions. He also noted that OPERF has substantial uncalled capital commitments to evergreen structures (like openend funds and separately managed accounts) as managers remain selective on the acquisition side, waiting to capitalise on distressed and discounted buying opportunities.
Around 70 per cent of the portfolio is in evergreen structures meaning distributions from income will become an increasingly large component of future portfolio cash flows.
“The market reached an inflection point in late 2022 with the 4th quarter ushering in an expected near-term trend of meaningful write downs across sectors due primarily to rising financing costs, increased cap rates and uncertainty around commercial tenant demand,” said board documents.
Positively, 2022 brought a resumption of travel for the real estate team, resulting in a return of in-person manager meetings, enabling analysts to better assess assets.
Approvals and fees
Last year the team approved nine real estate commitments totalling $1.75 billion. All 2022 commitments represented continuations or expansions of existing manger relationships in a reflection of the investment team’s high degree of conviction in its manager roster and the ability of these groups to execute.
Also underscored by the emphasis on evergreen partnerships which has meant that the frequency of new partnership underwriting has fallen.
According to board documents, last year’s core commitments resulted in management fees that averaged a 40 per cent discount to average fee structures for comparable open ended vehicles.
Non-core commitments included management fees that averaged a 15 per cent discount to average fee structures for comparable closed-end vehicles.
Targeting risk
The portfolio targets a long-term net return 50 basis points above the NFI-ODCE (26 largest equity open ended real estate funds in US) and aims to reduce risk among the portfolio’s investments through diversification by strategy, investment size, geography, and tenure.
The riskier corner of the portfolio comprises an allocation to value add and opportunistic strategies that use higher leverage and focus on investments driven by exits. Higher interest rates have particularly impacted these strategies, the council heard.
Real estate is currently within OPERF’s policy range of 7.5 per cent to 17.5 per cent but above the midpoint range of 12.5 per cent. The council heard how future discussions will review a strategy that currently holds onto core assets long term, rather than sell them as well as how to build international exposure to increase diversification.
DEI and ESG integration in the portfolio remains a work in progress as Oregon develops these themes collaboratively with its managers.
