One of the open questions coming out of last Fall was how would pension funds approach the looming (now underway) reversal in commercial real estate fortunes. Many observers pointed to the estimated hundreds of billions of dollars of sidelined institutional commitments in opportunity funds just waiting to get into the market at the right moment and cushion against severe value losses. But there was also talk about the denominator effect--where lowered stock portfolio values had increased real estate allocations above targets in consultants mixed asset models. That meant pension funds would need to sell down properties to meet pension consultant formulas just as the market swooned at the edge of a cliff.
Of course, many of these same consultants had been providing cover for pension funds to move into more opportunistic real estate investments--adding leverage and going into more risky high-growth overseas markets like China and India. In recent years, consultants were also pushing their plan sponsor clients to sign up with advisors (Wall Street high flyers) whose fees were heavily tied to promotes which would "better align" interests between investors and portfolio managers. The CEO of a more stodgy manager, complained to me last summer, that his firm was penalized by consultants for spreading bonus money around the firm rather than rewarding star portfolio managers with outsized payments.
Now after a year of a bear stock market and systemic financial meltdown --the consultant models are in shambles and pension plans wonder how they will meet future commitments to a splurge of baby boomer retirees in the next decade. The shortfalls among public funds will be especially severe. State and local governments will have no choice but to cut back on retiree payouts. Memo to public employee unions: look what is happening today with pension plans at GM and Chrysler. That's where you're headed too.
All this means that the capital cushion of sidelined institutional commitments for future real estate investments has lost its padding. Pension funds send signals to advisors that they will not be funding commitments. The queues grow to get out of open end funds. Consultants examine all the data they collect from advisors on fund performance and kick their computers. Their models don't count for much anymore.
At least falling real estate values will temper the denominator effect... at least.
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