UBS Trumbull Property Fund: Sitting out the real estate recovery

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1 April 2015 A Report by UNITE HERE Contact: Michael Pineschi mpineschi@unitehere.org UBS Trumbull Property Fund: Sitting out the real estate recovery Some investors have exited as UBS-TPF has fallen short of the ODCE benchmark in recent periods UBS Realty Investors LLC currently manages $26.2 billion in real estate in the US on behalf of institutional investors. 1 With $19.0 billion in AUM as of December 31, 2014, the UBS Trumbull Property Fund is the largest real estate product UBS offers. 2 The UBS Trumbull Property Fund which UBS describes as their actively managed core real estate product 3 has lagged the NFI-ODCE benchmark in short- and medium-term measurements. Since 2012, some limited partners have reduced or redeemed their UBS-TPF investment. At least one limited partner has put UBS-TPF on the watch list due to poor performance. Analysis shows that UBS-TPF performance has been below the NFI-ODCE benchmark in several recent and longer term measurements. The underperformance raises questions regarding UBS-TPF s investment strategy. During the great recession, performance was slightly better than the benchmark, albeit with negative returns. However, over the past four years of market recovery, the UBS-TPF has lagged relative to its peers in core, open-end real estate. Moreover, at a time when institutional investors are rigorously examining the benefits and costs associated with fees, UBS-TPF offers a complicated fee structure that may not be competitive compared to peers, and has charged an incentive fee to limited partners even when underperforming the ODCE benchmark. 4 Take Aways: Several LPs have drawn down their UBS commitment since 2012 At least one LP has placed UBS-TPF on the watch list for underperformance During the post-recession real estate recovery, UBS-TPF has lagged peers The UBS-TPF has underperformed the NFI-ODCE benchmark in 1-, 3-, and 5-year measurements The UBS-TPF has underperformed the NFI-ODCE benchmark in 16 of the past 18 quarters UBS-TPF has a complicated fee structure that may not be competitive relative to peers UBS has collected an incentive fee for each of the past four years 5 despite underperforming the ODCE index during each of those years. 6 Updated April 29,

2 Questions: Would other core real estate funds provide a better risk/return profile for investors? Institutional investors often have policies that guide tolerance of underperformance. Are other LPs considering actions based on UBS-TPF s persistent underperformance? Does UBS-TPF s investment strategy provide LPs with suitable performance, measured in short, medium and long terms? Does the UBS-TPF s conservative leverage strategy provide enough protection during economic downturns? Does the UBS-TPF s investment strategy provide enough upside for LPs during periods of growth? Are the UBS-TPF s fees appropriate given its frequent underperformance relative to peers? Limited Partners Have Redeemed or Reduced Investments in UBS Funds In recent years, several LPs have drawn down their investments in UBS. Some large as well as smaller UBS clients have opted to move part or all of their UBS Trumbull Property Fund allocation elsewhere. Source: Various reports on UBS-TPF from limited partners, and Real Estate IPE news reports. 2

3 The Ohio Public Employees Retirement System, one of UBS-TPF s largest investors, pulled $350 million from UBS-TPF in 2012, half of its commitment, in order to rebalance its portfolio. 7 OPERS removed the money 2 1/2 years after allocating it in The Minnesota State Board of Investment redeemed an investment of over $320 million in 2013, its entire UBS-TPF allocation. 9 Also in 2013, the St. Paul Teachers Retirement Fund Association drew down $40 million from the TPF, half of their commitment. 10 Elsewhere, the Chicago Parks Pension Fund redeemed around $11 million of its overall commitment to UBS funds in the first quarter of It drew down $5.5 million from UBS-TPF, and $5.5 million from the Trumbull Property and Income Fund another investment product of UBS in order to fund new mandates. 12 In April of 2015, The Chicago Teachers Pension Fund redeemed $80 million of their $160 million investment in the UBS-TPF, based on a recommendation by Townsend Investment Consulting Group. Townsend noted that the UBS-TPF is a defensive fund, and suggested its strategy may not be the most appropriate to take advantage of the current market cycle. 13 TPF Earned Watch List Placement The CTPF s decision to draw down its UBS-TPF investment came after Townsend advised the CTPF to place UBS-TPF on its watch list due to underperformance in January Townsend reported that Trumbull Property Fund (TPF) met the CTPF s two quantitative watch list criteria. First, it underperformed the ODCE for two consecutive quarters over a five-year rolling period. Second, it performed below the 50 th percentile relative to the ODCE peer group for two consecutive quarters over a five-year rolling period. Relative to peer funds, Townsend reported the UBS-TPF was in the 25 th percentile as of the third quarter Of the 17 funds examined for the 3Q14 5-year rolling period performance, 12 beat the benchmark, while UBS-TPF was among the 5 that did not. 16 Townsend noted that UBS-TPF had been on the watch list in 2Q14 and 3Q14 for ongoing underperformance. 17 Townsend recommended the CTPF Address potential weaknesses in Core portfolio; determine whether to rebalance existing funds or consider a new fund. 18 As a result, CTPF halved its commitment to UBS-TPF. 19 3

4 What recommendations are real estate consultants making to clients regarding UBS- TPF? For underperformance, what is a reasonable period of underperformance before placing a core manager on a watch list or reallocating funds to a different manager? In the current market how might the rebalancing of a real estate portfolio be advantageous for limited partners? Given the underperformance and market cycle, how many limited partners have recently redeemed or are considering redeeming their investment? UBS Trumbull Property Fund Lagged Benchmarks According to UBS, the TPF s performance objective is to outperform the NFI-ODCE index over any given three- to five-year period. 20 Recently, it has not met that objective. The UBS-TPF has underperformed the index in several different measurements as of December 31, 2014, looking at annual and quarterly performance. In an April 2014 review of several open-end real estate mangers for an LP, Milliman Investment Consulting examined the UBS-TPF and noted that In 7 out of the last 8 annual periods with positive real estate market returns, the fund has underperformed on a net of fee basis. 21 The 1-, 3-, and 5-year performance numbers from the UBS-TPF have trailed the benchmark as well as of December The 10-year number is above benchmark by a just 0.5%. 23 Source: UBS report to LPs February of On a quarterly basis, UBS illustrated in a recent report to a limited partner that the TPF has underperformed the ODCE in 16 of the last 18 quarters, dating back to mid-2010, 24 a period that coincides with the gradual recovery of the real estate market in the United States post-recession. The table below shows that UBS-TPF underperformed the NCREIF-ODCE in 9 out of 10 recent quarters. 25 4

5 Source: From NCREIF-ODCE and various reports on UBS-TPF from limited partners. Does the UBS-TPF Investment Strategy Provide Enough Upside for LPs? UBS has structured the fund with a strategy of using lower leverage as a way to mitigate risk. 26 The fund underperformed during the real estate market recovery, while also failing to provide more than a minimum buffer during the downturn of the recent financial crisis. UBS stated that much of the recent poor performance can be attributed to low leverage. However, it is difficult to judge private equity funds over the shorter time periods, especially given the recent economic recession and recovery. Longer time periods are required to more accurately assess performance. 27 However, several measurements of performance show UBS-TPF underperforming the benchmark in the longer term as well as in the shorter term. Source: UBS report given to LPs in February of

6 UBS-TPF s use of leverage remains one of the lowest in the NFI-ODCE peer group 13% as of April In the boom year of 2007, before the great recession, UBS-TPF underperformed the ODCE by a little more than 2.0%. 29 UBS-TPF s performance in the downturn year of 2008 was -7.5%, beating the benchmark by 2.5%. In 2009 UBS-TPF s total return was -22.3% beating the benchmark by 7.5% and 2009 represent two of the best recent years of market outperformance for UBS-TPF, but both years yielded negative returns for LPs. Townsend cited TPF s low-leverage, defensive strategy as concern and recommended a reduction in commitment by the Chicago Teachers Pension Fund. 31 Townsend said a more tactical core fund would be better able to take advantage of the current market cycle, and that a large percentage of the CTPF portfolio should not be dedicated to such a strategy. 32 In a core real estate search for an LP, UBS reported to Milliman Investment Consulting that total real estate assets lost in were greater than assets gained. 33 UBS TPF: Assets Gained (Millions ) Assets Lost (Millions ) Year Ending Dec $ $1, Year Ending Dec $ $1, Year Ending Dec $ $ TOTAL $1, $3, Would a more tactical core real estate fund be better positioned to take advantage of the current market cycle? Are LPs satisfied with the UBS-TPF strategy considering the fund s performance history? Does UBS-TPF s low-leverage strategy reduce risk compared to peers over the long term? Does the UBS-TPF strategy provide enough protection during economic downturns? Does UBS-TPF provide enough upside during periods of economic growth? Does UBS-TPF s strategy provide LPs with suitable performance in the long term? Complicated Fee Arrangement Relative to Peers At a time when institutional investors are rigorously examining fee structures and performance, UBS-TPF may not be competitive when compared to peers. When looking into the TPF s fee structure, Milliman noted that there is an incentive fee arrangement which is complicated. 34 Management fee rates for the UBS-TPF are similar to other products in the core space, 35 even though UBS s strategy has yielded lower returns than core fund peers. Additionally, unlike many open-end core funds, the fee structure for the TPF includes an incentive fee arrangement, resulting 6

7 in a maximum management + carry fee of 1.09% of net asset value 36 not including any other costs, acquisition fees, and disposition fees that may be charged to funds. 37 For an investment of $50 million, UBS-TPF base fee without the incentive added would be 0.79%. 38 The incentive fee can add up to another 0.25%. 39 TPF automatically adds an incentive fee of 0.15% on top of the management fee if the return objective is met. UBS sets the absolute return objective at CPI + 5% -- which it appears to have met in the last five years -- making that average fee for a $50 million investment at least 0.84% and in some cases up to 0.10% higher. 40 UBS has received an incentive fee for each of the past four years despite underperforming the ODCE index during each of those years. According to Milliman, The Incentive Fee Percentage is set at a fulcrum point of 0.15%, and ranges from a minimum of 0% to a maximum of 0.25%. The Incentive Fee Percentage increases or decreases ratably from the fulcrum point at a rate of 0.075% for each 1%, or portion thereof, that the Fund s gross return is above or below the Absolute Return Objective. 43 Why is UBS able to collect an incentive fee even when it underperforms the ODCE index? Would GP and LP interests be better aligned if the structure of the UBS-TPF incentive fee arrangement was tied to the ODCE? Are UBS-TPF management fees competitive compared to peers with better performance? After the management and incentive fee are calculated, how does UBS-TPF s fee structure compare to peers? How are management and incentive fees disclosed to UBS-TPF investors? How are other costs outside of the management and incentive fees disclosed to UBS- TPF investors? What performance fees did UBS collect from the Trumbull Property Fund during ? Endnotes 1 UBS. About Global Real Estate. Accessed on April, us/realty/about_realty.html 2 UBS. UBS Trumbull Property Fund (UBS-TPF): Ventura County Employees Retirement Association. February 23, UBS. UBS Trumbull Property Fund: Flash Report 3Q UBS Presentation given to the Chicago Teachers Pension Fund. April 23, UBS Presentation given to the Chicago Teachers Pension Fund. April 23, Based on CPI increases of 3.2%, 2.1%, 1.5%, 1.6% in 2011, 2012, 2013, and 2014 respectively. 7 Jon Peterson. Ohio PERS Takes Capital Out of Core Real Estate Funds. IP Real Estate. July 27, Accessed March Jon Peterson. Ohio PERS takes capital out of core real estate funds. July 27, Accessed March realestate.ipe.com/ohio-pers-takes-capital-out-of-core-real-estate-funds/46759.fullarticle 7

8 9 The Minnesota State Board of Investment 2013 Annual Report shows an allocation of $320 million. UBS is not present in the 2014 Annual Report. Accessed March Information found comparing the 2013 and 2014 Annual Reports. Accessed March index.php/publications/reports-2/ 11 Park Employees Annuity and Benefit Fund. Minutes from April 17, P Park Employees Annuity and Benefit Fund. Minutes from April 17, P UBS Presentation given to the Chicago Teachers Pension Fund. April 23, The Townsend Group. Chicago Teachers Pension Fund Real Estate Portfolio Overview. Third Quarter 2014 P The Townsend Group. Chicago Teachers Pension Fund Real Estate Portfolio Overview. Third Quarter 2014 P The Townsend Group. Chicago Teachers Pension Fund Real Estate Portfolio Overview. Third Quarter 2014 P The Townsend Group. Chicago Teachers Pension Fund Real Estate Portfolio Overview. Third Quarter P The Townsend Group. Chicago Teachers Pension Fund Real Estate Portfolio Overview. Third Quarter 2014 P UBS Presentation given to the Chicago Teachers Pension Fund. April 23, UBS. UBS Trumbull Property Fund (UBS-TPF): Ventura County Employees Retirement Association. February 23, Milliman Consulting. City of Miami Beach Open End Real Estate Search. P. 18 (date) 22 UBS. UBS Trumbull Property Fund (UBS-TPF): Ventura County Employees Retirement Association. February 23, P224, UBS. UBS Trumbull Property Fund (UBS-TPF): Ventura County Employees Retirement Association. February 23, P UBS. UBS Trumbull Property Fund (UBS-TPF): Ventura County Employees Retirement Association. February 23, P According to compiled data from UBS reports and NCREIF NFI-ODCE Snapshots. 26 UBS. UBS Trumbull Property Fund Quarterly Report: For the Quarter ended June 30, Employees Retirement System of the County of Milwaukee. UBS Realty Investors. Minutes of the January 15, 2014 Pension Board Meeting. Accessed March PDFdocs/ERS/Final-January152014PensionBoar.pdf 28 Milliman Consulting. City Miami Beach Open End Real Estate Search. P UBS. UBS Trumbull Property Fund (UBS-TPF): Ventura County Employees Retirement Association. February 23, P Milliman Consulting. City Miami Beach Open End Real Estate Search. P UBS Presentation given to the Chicago Teachers Pension Fund. April 23, UBS Presentation given to the Chicago Teachers Pension Fund. April 23, Milliman Consulting. City Miami Beach Open End Real Estate Search. P Milliman Consulting. City Miami Beach Open End Real Estate Search. P Milliman Consulting. City Miami Beach Open End Real Estate Search. P Milliman Consulting. City Miami Beach Open End Real Estate Search. P UBS. Form ADV Part 2A. Firm Brochure. March 31, Accessed April iapd/content/viewform/adv/sections/iapd_advallpages.aspx?org_pk=107758&rgltr_pk=50000&state_ CD=&FLNG_PK=03EB C02620BE005648C89056C8CC0&Print=Y 38 Milliman Consulting. City Miami Beach Open End Real Estate Search. P Milliman Consulting. City Miami Beach Open End Real Estate Search. P Milliman Consulting. City Miami Beach Open End Real Estate Search. P Based on CPI increases of 3.2%, 2.1%, 1.5%, 1.6% in 2011, 2012, 2013, and 2014 respectively. 42 UBS Presentation given to the Chicago Teachers Pension Fund. April 23, Milliman Consulting. City Miami Beach Open End Real Estate Search. P 174 8