Rising Economic Tide Lifts Returns on Investment Portfolios

If a rising tide lifts all boats, then surely the nation’s institutional investors are happy to see the latest wave of good economic news for a change. In the fourth quarter of 2010, the U.S. economy grew at a 3.2% annual rate, according to the U.S. Bureau of Economic Analysis.

Likewise, the largest U.S.-based public pension funds and endowments saw returns on their overall investment portfolios, including real estate, stocks and bonds, rebound to positive territory in 2010. While real estate returns remained a drag, signs are pointing to a rebound in the coming months.

The nation’s two largest pension funds, the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS), racked up total returns of 12.46% and 12.7%, respectively, on their overall investment portfolios in 2010.

With $225.7 billion in total assets under management, CalPERS’ results came in just under its target of 13.2%, according to spokesman Clark McKinley. CalSTRS, with $146.4 billion in total assets, outperformed its benchmark by 24 basis points. And though CalPERS’ real estate portfolio saw an overall decline of 5% for the year that ended Sept. 30, 2010, the drop was the smallest since the beginning of the financial crisis.

“During 2010, we reduced portfolio leverage and ended relationships with several real estate partners who didn’t meet our expectations,” says Joseph Dear, CalPERS chief investment officer. “Our current focus is on income-generating properties, and now that we’re beginning to see signs of a rebound in the market we’ll be ready to take advantage of opportunities as they arise.”

CalSTRS saw its real estate investments return a measly .01% in 2010, but positive nonetheless. That is a dramatic turnaround after seeing its real estate portfolio lose 18.7% in the three-year period that ended March 31, 2010.

Despite the overall positive trends, asset values of the majority of U.S. endowment funds still are about 25% lower than they were in June 2007. But at least they appear to be heading in the right direction.

According to Steve Pumper, executive managing director of Transwestern’s investment and asset services group in Dallas, lower capitalization rates in 2010 and 2011 are benefitting institutional owners of core assets. (The lower the cap rate, the higher the purchase price.)

“There is so much capital chasing too few deals. There is a flight to quality, particularly to investment-grade real estate. As a result, those with core assets have seen a significant rebound in values over the last 12 months,” says Pumper.

Cap rates for downtown office buildings ended 2010 at 6.2%, just 100 basis points above the heady levels of 2007, according to New York-based researcher Real Capital Analytics.

Educated guesses pay off

Public pension systems were not alone in seeing gains in 2010. U.S. educational endowment portfolios grew by 19.1% to $346.5 billion in the year that ended June 30, according to a new study of 850 U.S. endowments. The study was conducted by the National Association of College and University Business Officers (NACUBO) in conjunction with Commonfund, which manages more than $25 billion in assets for more than 1,500 institutions.

Harvard University solidified its top ranking among U.S. endowments, with total assets valued at $27.6 billion as of June 30, 2010. That is up 5.4% from the same date a year earlier.

Yale University placed second with $16.7 billion as of June 30, up 2%. Princeton University ranked third with assets of $14.4 billion, up 14.1%.

The University of Texas System in Austin was fourth with asset growth of 15.5% to $14.1 billion in the year that ended June 30. Meanwhile, Stanford University fell to fifth place from third last year with assets of $13.9 billion, up 9.8%.

The average performance of the universe of 850 endowments was 11.9% in the year that ended June 30, 2010, a stark contrast from the 18.7% decline reported the previous year, according to NACUBO’s president and CEO John Walda.

Endowments with more than $1 billion in assets produced the best average return of 12.2% as of June 30, followed by institutions with $25 million to $50 million of assets, which had an average return of 12%.

Continued challenges ahead

Despite the recent positive news, over the three-year period ending June 30, 2010, U.S. endowment returns were negative, with an average return of -4.2% for the period.

Moody’s Investors Service, the New York-based rating agency that rates every state’s creditworthiness based on its bond debt, is presenting a new challenge to the health of many public pension funds.

In late January, Moody’s announced that it would begin to recalculate the states’ debt burdens to include unfunded pensions. Typically, states do not now show their pension obligations on their audited financial statements. Given the recent attention being paid to states’ unfunded pension liabilities, investors have become more nervous about the health of municipal bonds.

Adding to the unknowns ahead, governors across the country are ramping up efforts to reform their state pension plans, with many top mayors addressing the issue in their recent annual “state of the state” addresses to legislators.

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