2016 Real Estate Asset Class Review June 23-24, 2016 Tom Masthay, Director – Real Assets Eddie Schultz, Investment Analyst Rachel Cleak, Investment Analyst
Agenda I. Executive Summary II. Performance & Implementation Review III. IPS Compliance & Portfolio Review IV. Real Estate Market Update V. Milestones & Initiatives VI. Appendix: Manager Scorecards 2
I. Executive Summary
Real Estate Asset Class Objectives IPS Stated Objective for the Real Estate Portfolio “To enhance total return and provide diversification to the overall investment portfolio.” A primary goal of the annual review presentation is to discuss the real estate portfolio and market conditions relative to IPS stated performance goals: Long term performance objective is a real rate of return (adjusted for inflation) of five percent (5%) net of investment management fees. The market update addresses the nature of this objective. The real estate portfolio is expected to generate returns, net of all fees and expenses, in excess of their respective indices, over rolling five year investment time horizons. The performance review section analyzes this objective and associated benchmark indices. 4
Comprehensive Annual Review Process Why do we conduct annual reviews? Per the TMRS IPS, comprehensive reviews are to be conducted and documented at least annually. The goal is to formally review managers’ performance, current investment strategy or style relative to that which was communicated, and other issues related to the managers’ organization, personnel, or investment philosophy. The annual review process is part of the IPS manager retention framework. The annual review & ongoing monitoring processes may include but are not limited to: SEC Form ADV reviews SSAE16 and other operational audit reviews The Annual Review process Compliance Certifications holds TMRS accountable for Detailed Performance Analyses Manager Meetings being self-critical of its portfolio Quarterly Monitoring Documentation management process in order Manager Annual Meetings Limited Partnership Advisory Committees to preempt manager specific, Strategic Portfolio Reviews strategic, or other potential Meetings with comparable managers Market Research problems. Attending Conferences 5
Real Estate Timeline Review (2015-2016) • Consultant RFP process completed and contract with Courtland Partners Q1-Q2 2015 signed. • Board approves 8 new real estate funds for approximately $800 Q3 2015 million in new commitments. • December 2015 Board Meeting: Board approves 2016 Real Estate Q4 2015 Search processes in an amount up to $600 million in new commitments. • Board approves 3 new real estate funds totaling $475 million in new Q1-Q2 2016 commitments to bring the portfolio to approximately 100% implemented. A comprehensive discussion of the timeline implementation of the real estate portfolio is provided for in the following section. 6
Real Estate Portfolio has Reached Full Allocation Manager Selection Priorities Blue-scale: Core Mandates Purple-scale: Value-Add Seeking top performing Orange-scale: Opportunistic managers to form beneficial partnerships for the TMRS real estate portfolio. The number of partnerships is being watched closely so monitoring and maintenance does not become an undue cost. Sizing of manager relationships remains critical, based upon portfolio needs, manager capabilities & opportunity set. This pie-chart is built off of through the remainder of the presentation to assess portfolio risk and implementation progress from a data-oriented perspective. 7
Market Value & Unfunded Commitment Summary TMRS’ Real Estate portfolio on a market value basis is approximately 6% of the total portfolio today. The following section takes a more detailed look at investment pacing and how the time dimension is incorporated into decision making. *Source: Courtland Partners *As of Q1 2016 the total number of real estate investment vehicles is 27 (with the addition of DivcoWest V, Blackstone PP, Kildare EP II, Rubenstein PF III, and H/2 Core debt) and updated unfunded commitments are $1,641,665. 8
II. Performance & Implementation Review Performance Review as of December 31, 2015 *Unless otherwise noted in this section, performance presentations do not include Harrison Street Securities, TMRS’ only public securities mandate in the real estate programs history. This mandate was terminated by the Board at the July 29-30, 2015 Board meeting and subsequently closed out of in August 2015.
Remember the J-Curve! The J-curve exists in large part due to fees and expenses being a high percentage of capital deployed early in a fund life. Conservative early marks being applied to portfolio investments can also contribute. J-Curve Effect $150 50% Outlay $100 Inflows 25% IRRs $50 Cash Flows IRRs $0 0% ($50) -25% J-Curve representation is that of ($100) a private equity fund. ($150) -50% Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Think of the J-Curve not just in terms of performance, but diversification as well. Portfolios early in their lives tend to be very concentrated as few deals have been completed. Note 1: The “Diversification J-Curve” is more relevant to early stages of investing in a new product core fund. Capital is drawn sequentially from fund investors 10 – early investors fund the first deals and as more deals are added more investors are added to the pools. Diversification thus comes later.
Sector/Strategy Returns by Manager *Only managers with capital deployed as of 12/31/15 are included in this table; Source: Courtland Partners Returns can vary greatly depending on the stage of portfolio development a fund is in. This concept can apply to portfolios of funds as well. 11
Income vs. Appreciation Analysis Performance Attribution: Income vs. Appreciation (by gross returns) 20.00% 18.00% 16.00% 14.00% 12.00% 12.09% 11.90% 9.80% Appreciation 10.00% Income 7.90% 8.00% Source: Private Edge 6.00% 4.00% 5.30% 5.28% 4.40% 4.30% 2.00% 0.00% 2012 2013 2014 2015 TMRS’ portfolio returns can be broken down into income and appreciation return streams. The market has generally seen income come down as cap rates have compressed. Note 1:Private Edge data was used for this analysis in lieu of Courtland Partners due to the explicit itemization of income figures into templates utilized by Private Edge and therefore the more direct accounting of income vs. appreciation. Courtland Partners’ data, shows opposite directionality of income growth noting income of 4.70% in 2015 and a 3 year aggregate income of 5.20%. The conclusion to draw is that income has been in the 4.3 – 5.3% range % since 12 the inception of the portfolio.
Portfolio Cash Flow Activity & Evolution Annual Aggregate Cash Flow & Performance Attribution 500,000,000 462,353,288 391,034,314 400,000,000 300,000,000 259,013,948 “Net Inflows” means 230,677,962 dollars going into a fund 200,000,000 vehicle, i.e. TMRS sends money to a fund. 97,000,000 100,000,000 “Net Outflows” means dollars coming out of a fund, i.e. TMRS receives - money from a fund. (6,028,342) (50,278,024) (100,000,000) (102,363,822) (200,000,000) (173,137,461) (300,000,000) Net Inflows Net Cash Outflows Net Income & Appreciation As time has progressed, income and appreciation have picked up commensurately with cash flow activity. 13
Analyzing Portfolio Implementation Understanding the current portfolio, its performance, and expectations portfolio requires understanding its history. Key Metrics of Analysis Active Commitments – Real estate commitments approved by the board and currently a component of TMRS’ real estate portfolio . Adjusted Commitments* – Not all commitments are created equal. A core open-end equity fund and an opportunistic fund have very different evolutions in fund market values. In order to accommodate this at any single point in time, a conversion factor is applied to closed-end funds. The adjustment translates the concept of a commitment to an expected market value which is a more meaningful data point when managing a portfolio. Effective Vintage Commitments – TMRS has approved many follow-on commitments to previously approved funds. This figure consolidates follow-ons into the initial approval year. EVC is a decision assessment tool used to help understand the higher order effects of the initial decision to invest in a manager by allocating portfolio implementation progress to that period. This figure helps assess IPS compliance by being an input into the metric noted below. Vintage Year Contribution – VYC assesses today’s portfolio and the role various effective vintage commitments have on it. The IPS limits vintage year exposure concentrations – this metric is a more meaningful way to assess TMRS’ portfolio than commitments by themselves. *Greater detail on the Adjusted Commitment methodology is provided in Board real estate recommendation memorandums from 2015 & 2016. In 14 summary, the adjustment removes explicit visual representation of time dimensionality from a pacing model for simplification of presentation.
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