Real estate is fingered as the culprit for the more modest returns that four of Canada’s largest pension funds reported for the first half of 2024. The beleaguered asset class is currently taking its turn as the underperforming piece in a diversified mix of holdings, but newly released commentary from the credit rating agency, Morningstar DBRS, underscores that large pension funds are still delivering positively due to stronger returns from other asset classes, particularly public equities.
“Notwithstanding the recent market volatility, we expect 2024 performance to be similar to what was observed in 2023 with positive returns from large pension funds. However, given the negative returns in the real estate sector in H1 2024 and in FY2023, we anticipate large pension funds to reposition their real estate portfolios,” the commentary states.
Morningstar DBRS analysts look at Canada Pension Plan Investment Board (CPP Investments), Caisse de dépôt et placement du Québec (CDPQ), Ontario Municipal Employees Retirement System (OMERS) and Ontario Teachers’ Pension Plan (OTPP), which, for the first half of this year, lag 10-year historical returns in the range of 7.3 to 7.6 per cent for OMERS, CDPQ and OTPP and 9.2 per cent for CPP Investments. CDPQ and OMERS divulged negative returns from real estate — of -3.6 per cent and -3.1 per cent, respectively — while CPP Investments and OTPP did not specifically report on real estate performance in their interim results.
Looking back to 2023, and also adding in Alberta Investment Management Corporation (AIMCo), British Columbia Investment Management Corporation (BCi) and Public Sector Pension Investment Board (PSP), the commentary highlights negative real estate returns ranging from -5 to -16 per cent for the year. The declining value of Class A office properties is upheld as a major factor.
“Many large pension funds are adjusting their real estate investment strategies by disposing of real estate investments whose returns are not expected to improve over time,” the commentary observes. “CPPIB sold two Vancouver towers (with OMERS selling its stake as well), two Manhattan projects, a Southern California business park, and some real estate holdings in India. OMERS also reduced its real estate allocation to 14.8 per cent in 2023 from 16.8 per cent in 2022.”
Morningstar DBRS analysts foresee a continuation of this trend, with large pension funds shifting their real estate allocations from office and retail to industrial, logistics, life sciences and data centres. They also note a move away from being owner-operators toward portfolio investing, “thereby increasing diversification by owning a larger variety of real estate properties”. In the larger asset mix, they also anticipate greater investment in infrastructure and private credit.
Six of the seven large pension funds boast a stable AAA credit rating, with PSP pegged at stable AA (High). “Over the years, large pension funds have grown into some of the largest and most sophisticated global investors exemplifying an investment model that has gained international recognition and interest from countries seeking to set up similar institutions,” the commentary advises.
