New Sources of Capital from Target Date Funds October 16, 2012 National Association of Real Estate Investment Managers Moderator: Lennine Occhino Mayer.

New Sources of Capital from Target Date Funds

October 16, 2012

National Association of Real Estate Investment Managers

Moderator:Lennine OcchinoMayer Brown

Panelists:Joshua Cohen Leonard Kaplan Laurie TillinghastRussell Investments Prudential Real Estate Investors UBS Global Real Estate – US

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Distribution of US Private Pension Plan AssetsBy Plan Type 1975 – 2009

Source: U.S. Department of Labor: Form 5500 Annual Reports

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Distribution of US Private Pension Plan ContributionsBy Plan Type 1975 – 2009

Source: U.S. Department of Labor: Form 5500 Annual Reports

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Custom Target Date Fund Opportunity

• Assets in C-TDF about $54bn today – Projected growth to $530bn through 2015

– $450bn + increase next 3 years

• Of the $3.7 trillion in TDF assets by 2020 – 37% estimated to be in customized portfolios

Approaching $2 trillion in C-TDFs in next 8-10 years

Sources: Celent, CaseyQuirk, Morningstar, Consultant firms

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Fiduciary Considerations in Using Institutional Commercial Real Estate

Key Considerations

ERISA

Risk/Return

Diversification

ERISA 404(c)

Cash Flow

QDIA

Prudence Standard of Care. Same as for a Defined Benefit Plan

The projected risk/return of the portfolio relative to the objectives of the target date/target risk fund or investment option

Lower correlations with public equities and public fixed investments

The Plan must offer participants the opportunity to give investment instructions among “a broad range of investment alternatives”

Liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan

“applies generally accepted investment theories, is diversified so as to minimize the risk of large losses and that is designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures…,” such as balanced funds and target date funds

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Sample Target Date Fund Glide Path

Source: Russell Investments. For illustrative purposes only.Please remember that all investments carry some level of risk. Although steps can be taken to help reduce risk it cannot be completely removed.

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Why Custom?

Casey Quirk/PSCA April 2009 Survey of 397 plan sponsors. 61% use target date funds as the default.87% use off-the-shelf target date funds. 13% use custom target-date funds.

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Russell’s Target Date Asset Allocation (early in glide path)Process depends on client fee sensitivity and risk tolerance

100%90%80%70%60%50%40%30%20%10%

0%Core

PortfolioModel

PortfolioEnhanced Portfolio

US Large Cap EquityUS Small Cap EquityInternational EquityListed Real AssetsCore Fixed Income

Global High YieldGlobal EquityEmerging Equity

AlternativesPrivate Real Estate

Core Portfolio + Model Portfolio +

Hypothetical portfolios shown for illustrative purposes only.

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Where does a direct RE product fit in a DC Plan?

Direct RE

3-10% of a Diversified, Custom Asset allocation or Real Asset fund

TargetDate Fund

Target Risk Fund

Custom BalancedFund

Real AssetFund

DiversifiedInflation Fund

Other Criteria:• Total Plan assets equal or greater than $500M• QDIA is TDF, TRF or Balanced Fund (lifecycle, lifestyle)• Custom (generic name) with “open architecture” • Staff with “DB-like thinking”

ManagedAccount

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DC Real Estate Fund: “30,000 Foot View”

DC RE Fund

Private Real Estate Fund(s): 60-100%

Liquidity Components: 0-40%(REITs and/or cash)+

NAV determined by RE Manager and/or 3rd Party

Overall Fund NAV determined by custodian

NAV determined by fund(s)

C-TDF

Record keeper determines NAV

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Liquidity ManagementManaging cash flows and liquidity needs of TDF Managers and Plan Sponsors

Factors to Consider• TDF Cash Flow• Rebalance methodology• Events that may trigger a material

change in cash flows; i.e., reenrollment, new participant enrollment, plan design changes

What to ask a Real Estate Manager• Are there liquidity queues to get in

and/or out of private real estate?• Does the manager deploy a multi-

fund approach or single strategy?• Utilize line of credit or back stop to

guarantee liquidity

PlanTDF

15% to 40% of Plan Assets

Real Estate 5% to 15% Allocation

Credit Line5-15%

Cash/REITs0-40%

Private Direct Property60-100%

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Liquidity Versus Optimal Allocations

Cash/REITs20-40%

Direct Private Property60-80%

• Optimal allocation to produce desired outcome in TDF

• Trade off between liquidity and optimal allocation

• What is the real liquidity risk?

Liquidity Range0%

Private Direct Property

100%

Publically Traded REITs

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Valuation MethodologiesRange of Approaches

Partially outsourced to 3rd PartiesValued

In-house

Valued by 3rd

Parties

• Transparency• Integrity of the internal

model• Frequency of change• Conflicts of interest• Organizational

confidence in change notification process

• Materiality levels• Frequency of change• Strength of market

database• Organizational

confidence in change notification process• Access to accounting

records of manager

1) Individual property appraisals

2) Appraiser review process at Fund level

3) Intra-quarter changes; capital deployed, extra-ordinary revenue/ expenses

4) Net operating income and changes thereto