A Survey of Pension Fund Real Estate Portfolio Risk Management Practices

Institutional real estate investmentà à primarily pension reserve assetsà à grew rapidly in the 1980s. The fiduciary demands of a growing asset pool coupled with disappointing results in the latter half of the decade led to an increasing interest in the application of Modern Portfolio Theory (MPT) to the management of large-scale real estate portfolios. This paper reports the results of a study conducted in mid-1990 that surveyed the 426 largest institutional portfolios on portfolio management practices relating to diversification strategies, risk measurement, and evaluation of investment returns. The survey replicated several measures gathered by Webb in a 1983 survey to assess the rate of acceptance or utilization of ideas and techniques in the portfolio management community. Results indicate that change is perhaps slower than might be expected. Real estate performance measures have become more sophisticated in the past seven years with a shift away from accounting type measures toward fully discounted measures, including several variations on the Internal Rate of Return (IRR). Risk-adjustment techniques have changed to the extent that portfolio managers have a greater likelihood of using sensitivity analysis, but few other innovations are widespread. Only a small percentage of respondents use traditional tools of MPT-based analysis, but the majority are cognizant of the recent developments in the literature that attempt to show alternative methodologies for achieving true diversification within real estate portfolios. The results indicate that change is gradual and that some practices that have been discredited in the academic literature for many years may still be evident in the institutional community.