The Frankfort, Ky.-based Kentucky Retirement Systems (KRS), with $17.6 billion in assets under management, has embarked on an approximately $350 million strategic investment partnership with Barings, a global investment management firm, and Barings parent company, Mass Mutual, to launch the Barings Real Estate European Value Add I Fund.
According to Andy Kiehl, director of real estate and real return investing at KRS, “We have made a concerted effort over the last two years to seek out asset managers and GPs [general partners] that offer an attractive value proposition, favorable LP [limited partner] economics and a true ‘alignment of interest’. We believe that LPs don’t just have to accept GP-friendly terms like fees on committed capital, catch up carry provisions or long-dated funds with extensions.”
When approached by Barings initially, KRS was interested in the strategy and opportunity in Europe. And, after hearing that the seed capital of approximately $90 million was from Baring’s parent, Mass Mutual, KRS proposed the idea of a strategic partnership, in which it would invest side by side with Mass Mutual and provide half of the capital Barings was looking to raise for the fund, Kiehl explained.
“For KRS and the benefit of our plans, we are looking to be an important piece of capital to the GP, and we believe co-investing shoulder to shoulder with the parent company makes us pretty important. In the interest of efficiency, we are looking to have larger, broader, multi-faceted relationships (where possible) with established institutional firms, and Barings and Mass Mutual fit the bill,” Kiehl said.
KRS was approached by two Barings managing directors, James Fink and Kevin Ryan, earlier this year with an opportunity to join with the firm in its launch of a European real estate investment fund. The strategy will seek investment opportunities in value-add real estate in Europe. The fund will target assets in office, retail and logistics for repositioning and exit. The Barings team may also look for development and special situations opportunities, but only as a minority allocation in the fund.
The Barings Real Estate European Value Add I Fund will close this quarter, and is scheduled for a three-year investment period. Kiehl noted, however, that with seed assets already in hand, and absent the burden of a second, third or fourth closing, the Barings team believes the fund’s capital can be deployed even more quickly than originally anticipated. “It’s just another benefit of the strategic partnership. Pace of deployment and return of capital are important considerations of GP/LP investment vehicles. Giving Barings the ability to execute the strategy more quickly than they could have otherwise is beneficial for both parties.”
KRS’ agreement with Baring s requires no fees to be paid on committed capital, only on drawn (invested) capital. “What this means, is that we are not charged until our money is invested,” Kiehl said, adding there is also no catch up carry for the GP. “Many of the GPs and fund constructs will apply a “catch-up carry”, which means once they deliver a stated return, they then go back and collect an incentive fee on that return, and then an additional 20% on all other returns delivered. In our agreement with Barings, we have an agreed upon ‘hurdle’ return, and once delivered, they will only collect an incentive fee or carry on the return above the hurdle rate.
The fund’s investment strategy is to acquire mispriced or mismanaged assets in supply constrained locations in major European markets, according to a Barings spokeswoman. The investment focus will be on leasing or capital improvement opportunities primarily within the office, retail and logistics sectors, she said. “This asset-level strategy will be driven by stock selection and active asset management and informed by both cyclical and long term structural factors,” she said, declining comment on the fund’s fees or anticipated returns.
KRS’ real estate allocation is approximately $615 million currently, representing a little over 3% of its AUM. “The European real estate fund represents about 1% of assets, so that takes our RE position up to about 4%.” The Kentucky plan includes real estate in what it has labeled a “diversifying” bucket, the allocation to which stands at 25%.
KRS is one of the nation’s most severely underfunded public pension funds. According to the Pew Charitable Trusts, among state-sponsored retirement systems, those with the poorest funded ratios are New Jersey and Kentucky, at only about 31% funded, and Illinois, at 36% funded. Kiehl said that “not unlike many other state pension plans, we have experienced some challenges; we’re underfunded. We’ve had staff turnover. But for the last going on three and a half almost four years, the same group of staff—just four of us—along with a pretty sophisticated investment committee, are just doing some interesting [investment] things.”