South Korea's largest pension fund sinks $300M in Starwood Capital fund


The largest institutional investor in South Korea is taking a shine to hotels—in a big way.

According to South Korea's Pulse News, the National Pension Service (NPS), the third-largest pension fund in the world with some $452 billion of assets under management, is investing $300 million in a hotel fund managed by Starwood Capital Group, led by Barry Sternlicht.

The investment comes as the fund's CEO comes under fire for reportedly meddling in a controversial merger of two Samsung units.

Fund Nature

While pension funds investing in hotels is not revolutionary, it is uncommon due to the risky nature of hotels compared to other asset classes, like office and multi-family. In the case of NPS, which does already invest in the U.S., mainly in large cities and in office buildings, it's the first time that it has invested in hotels.

Pension funds are responsible for handling the money of retirees, and are meant to ensure that retirees receive benefits. Pension funds, then, are usually conservative in investments, concentrating on government securities, investment-grade bonds, and a small amount placed in blue-chip stocks.

Pension funds have to match liabilities over a long time period, so most funds are a blend of bonds and securities. They have to pay retirees out for long periods and, for instance, a 30-year bond will pay out at the time it matures.

And while pension funds are naturally conservative, most have "alternative buckets," wherein they will invest somewhere in the window of 5 percent up to 20 percent in things like real estate. Maintaining a high rate of return leads funds to this.

Consider This

Back in November 2007, for example, the San Diego City Employees Retirement System made a $20-million investment in the Cornerstone Hotel Income and Equity Fund II commingled fund. At the time, the hotel industry was showing strength with fundamentals expected to continue to be strong for the next few years to come.

A month later, the U.S. and the world was beset by The Great Recession. In down or mediocre economic times, hotels frequently suffer more than other asset classes. Consider this: The National Council of Real Estate Investment Fiduciaries’ (NCREIF) Property Index, which measures a total rate of return for properties acquired on behalf of tax-exempt institutional investors—mostly pension funds—reported that retail proved the best-performing real estate sector for tax-exempt institutional investors in 2012, delivering a return of 11.6 percent followed by multifamily, at 11.2 percent, and industrial properties, at 10.7 percent. Hotels were the worst performing asset class that year, with total returns of 8.2 percent.

Pension funds usually seek out a leveraged rate of return of 10 percent or higher. In the case of foreign pension funds, a banking source told us that, usually, they are less conservative investors than U.S.-based pension funds.

The Starwood Capital fund NPS is investing in, dubbed the SCG Hotel Investors Fund, is notable for another reason: it's reportedly "dedicated to small- and medium-size hotels in the outskirts of major cities in the U.S."

That can mean select-service hotels in locations being regularly referred to as "surban": a mix of urban and suburban living that offers a plethora of entertainment and F&B options. These areas are usually right on the outskirts of major cities, a favorite of  the millennial set for its attribute of urban living at suburban pricing.

As Pulse points out: "NPS expects to raise stable profit considering that most of the investment assets are business hotels that are less affected by economic fluctuation. The investment is expected to bring an annual return of more than 10 percent."