Bloomberg story on HH Aga Khan's Dealings Stir Questions of Financial Transparency

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Aga Khan's Dealings Stir Questions of Financial Transparency

Nov. 23 (Bloomberg) -- As 50,000 followers watched, Sultan Mohamed Shah Aga Khan III, wearing a silk coat and blue turban, hefted his 243.5 pounds onto a brocade chair connected to a scale loaded with diamonds. The event in India in 1946 was to mark the 60th anniversary of his role as spiritual leader of the Ismaili Muslims and to raise cash from his followers.

Shah's grandson and successor, His Highness Prince Karim Aga Khan IV, still collects cash from his followers, who typically tithe 12.5 percent of their income to the imam. He has chosen a quieter approach than his ancestor.

``The Western world saw this as a Muslim leader being weighed in a very public ceremony and all that money going into his pocket,'' the Aga Khan, 68, says. That's incorrect, he says. ``I don't think any reasonably educated Western individual would think that all the assets of the Vatican belong personally to the pope,'' he says.

Unlike the pope, who received $51.7 million in 2004 from Catholic contributions known as Peter's Pence, the Aga Khan won't say how much he raises from his followers each year or break out how the money is spent. Nor will he disclose all the sources of the $325 million that his development network, which has diplomatic status in 10 countries, plowed into projects last year.

And he won't give performance figures for the Aga Khan Fund for Economic Development SA, a Geneva-based holding company that owns stakes in 90 companies. All profits and dividends from the companies and projects are reinvested, he says.

Transparency

Such secrecy about finances isn't warranted, says Jermyn Brooks, a Berlin-based director of Transparency International, a nongovernmental organization that monitors corruption and promotes accountability.

``They are engaged in the public sphere, they claim special status, they collect funds from members of the public and governments, so they should publish their accounts,'' Brooks, 66, says. ``Accountability and transparency are the other side of the coin of trust and credibility.''

The scarce information about Ismaili finances bothers Akbarally Meherally, 77, whose father helped load diamonds onto the scales in 1946 after making a large cash donation. ``He has never submitted any proof of what he's doing with Ismaili tithes,'' Meherally says of the Aga Khan. He quit the sect in 1988. ``The lack of transparency was one of the reasons,'' he says.

Private Tithes

The Aga Khan says Ismaili tithes are a private, religious matter. His institutions disclose relevant information to donors, lenders and investors on individual projects, says John Ferguson, a spokesman for the Aga Khan. Unlike aid organizations such as Oxford, England-based Oxfam, the Aga Khan doesn't actively solicit funds from the general public, Ferguson says. Any donations are accounted for, he says.

In addition to money from his Ismaili followers, the Aga Khan obtains bank loans and grants from Western governments and aid organizations to finance his empire. The Aga Khan's companies, with total sales in 2004 of $1.36 billion, stretch from Pakistan's No. 2 lender, Habib Bank Ltd., to Kenyan bean farms, to the just-opened Serena Hotel in Kabul, where rooms start at $250 a night -- about what the average Afghan makes in a year.

He also owns stakes in two car dealerships in Edmonton, Alberta: Mayfield Toyota Ltd. and T&T Honda Ltd.

The Aga Khan has also expanded the institutions started by his grandfather into a nondenominational network of 325 schools, two universities, 11 hospitals and 195 health clinics in 30 countries, mostly where poorer Ismailis live, from Tajikistan to Uganda.

Fees

Most of the institutions charge their clients -- even the poorest -- fees. A 74-acre (30-hectare) public park he opened in March 2005 in Cairo charges three Egyptian pounds (52 U.S. cents) to enter.

The Aga Khan says his goal is to create schools and hospitals that can support themselves, while fostering economic growth in the world's poorest countries.

``They're fee paying because in the long run, what you're trying to do is to create self-sustaining institutions,'' says the Aga Khan, a British citizen who travels with a French diplomatic passport and lives in a chateau 26 miles (42 kilometers) north of Paris. ``You've got to get the economy moving.''

`Philanthropy, Not Charity'

Outsiders say that approach makes sense. ``The Aga Khan is promoting self-reliance,'' says Vartan Gregorian, 71, president of New York-based Carnegie Corp., which awarded the Andrew Carnegie Medal of Philanthropy to the Aga Khan in October. ``It's philanthropy, not charity.''

Adds Paul Kaiser, 43, associate director of the University of Pennsylvania's African Studies Center, who has studied Ismaili health services in East Africa, ``Services can be expensive for locals, but that doesn't undermine that the expertise wouldn't be there otherwise.''

Such efforts aren't always welcome, particularly among more conservative proponents of Islam. In 2003, the Karachi-based Aga Khan University got $4.5 million from the U.S. Agency for International Development to start a new, Western-style exam board for schools. That angered conservative clerics and politicians who view the U.S. with suspicion.

Qazi Hussain Ahmad, president of Pakistan's Jamaat-e- Islami, a religious opposition party, urged the university to scrap the plan.

Looting and Burning

In May, a mob looted and burned the Aga Khan Development Network office in the northeastern Afghanistan town of Baharak. ``We're seen as key implementers of projects undermining the mullahs, and they hate it,'' says Aly Mawji, 36, a British Ismaili who is the Aga Khan's representative in Kabul, with diplomatic status. ``If we don't take action, we are leaving these places to turn into breeding grounds for extremism.''

In Afghanistan, the development network, the Aga Khan's umbrella organization, has built schools, hospitals, roads and bridges and owns 51 percent of Roshan, the country's biggest cell-phone service company.

The Aga Khan's lifestyle -- he owns stables of Thoroughbreds and races speedboats, and his second divorce is being dissected in Europe's gossip pages -- is criticized by some Muslims. ``Racehorses involve gambling, a major sin in Islam,'' says Azzam Tamimi, 50, a spokesman for the London-based Muslim Association of Britain. ``His hotels sell alcoholic drinks, which Islam prohibits. You cannot as an imam be associated with any of this.''

Divorce

James Wolfensohn, 71, former head of the World Bank who has known the Aga Khan for 20 years, says he regards him as two people. ``One is the public face, who sustains the highest standards in the developing world,'' he says. ``The other is the gossip stuff, and I have no comment on that.''

A French court is hearing his second divorce, from Gabriele zu Leiningen, a German-born former pop singer and law graduate who's 26 years his junior. His first wife, British former model Sally Croker-Poole, auctioned $27.7 million of jewels, including the 13.78-carat Begum Blue diamond, after their divorce in 1995. Both wives took Arabic names and converted to Islam when they wed.

``She is a woman scorned,'' says Tim Bell, a London-based media adviser hired by Begum Inaara, as zu Leiningen, 42, is now known. ``She wishes to get a financial settlement and move on.''

The Aga Khan's personal fortune includes stud farms in France and Ireland that have yielded four English Derby and three Prix de l'Arc de Triomphe winners since 1981. In the 1960s and 1970s, he developed a virgin strip of coast on the Italian island of Sardinia into Costa Smeralda, where Italy's billionaire prime minister, Silvio Berlusconi, and others have vacation homes.

Malta, Ibiza

And in 1992, the Aga Khan and his friend Gianni Agnelli, the late Fiat SpA chairman, smashed the transatlantic speed record with their 220-foot (67-meter), 50,000-horsepower speedboat Destriero.

The Aga Khan currently owns an undeveloped piece of coast on the Spanish island of Ibiza, and he's considering plans for a luxury development on Malta and a project to transform a military arsenal on the Italian island of La Maddalena into a harbor for big yachts, says Enzo Satta, 60, a Sardinian architect who says he has worked for the Aga Khan on the ventures.

Ismailis dismiss questions about the Aga Khan's wealth and private life. ``What's important is the guidance he gives and the development of the unique network he has created,'' says Naguib Kheraj, 41, a British Ismaili who's chief financial officer of Barclays Plc, the U.K.'s third-biggest bank.

Prophet Muhammad

Born in Geneva to an English mother and half-Indian, half- Italian father, the Aga Khan claims descent from Fatima, the daughter of Islam's prophet Muhammad, via the Fatimid rulers, who founded Cairo in 969 A.D. They later transferred to Syria and Iran, where they were known and feared by medieval European crusaders as the Assassins.

The Aga Khan's great-great-grandfather moved the family to India in 1842 after leading an unsuccessful revolt in Iran and then assisting British officers on military campaigns in Afghanistan.

Sultan Mahomed Shah, the Aga Khan's grandfather, became imam in 1885 and served as president of the League of Nations, the doomed forerunner of the United Nations, from 1937 to 1939. During his lifetime, Indian-born Ismailis built communities in East African countries such as Kenya and Tanzania, which were also part of the British Empire.

Rita Hayworth's Stepson

Shah unsuccessfully petitioned the British government for land for his own state. Following World War II, many Ismailis, whose numbers are estimated at 15 million by the Aga Khan's secretariat in France, moved to Europe and North America.

Shah, who was married four times, skipped his eldest son, Aly Khan, and anointed his grandson Karim to succeed him. Karim became the Aga Khan at age 20 in 1957, when Shah died at age 79. Karim's younger brother Prince Amyn, 68, is now a director of the Aga Khan Fund for Economic Development. Hollywood's Rita Hayworth was Aly Khan's second wife and Karim's stepmother. They had a daughter, Yasmin.

Educated at Switzerland's Le Rosey private school after spending World War II in Kenya, the current Aga Khan studied Islamic history at Harvard, where he earned a bachelor's degree, with honors, in 1959.

As the imam approaches the 50th year of his reign, he says he wants to be known for his philanthropy and his faith. ``The facts are there, but they're not very visible in the Western world because it's all happening in the developing world,'' he says.

Kenyan Farmers

One example of how his program works can be found among the 20,000 subsistence farmers in Kenya's central highlands who are under contract to the Aga Khan's Frigoken Ltd.

Farmer Jane Njeri, a 25-year-old mother of four, picks ripe beans and places them into a cracked, white plastic beaker tied around her waist. Frigoken supplies her with seeds and fertilizer, guarantees a purchase price for the beans and packages them for export to Europe.

Frigoken pays Njeri about 10,000 Kenyan shillings ($132) a year for her beans, more than three times what she earns from the sale of other crops such as bananas and sugar cane. ``I'll use the money to pay my children's school fees,'' she says.

Frigoken is owned through the Aga Khan Fund for Economic Development, which aims to develop profitable companies that bring jobs and services to some of the world's poorest countries, says Anwar Poonawala, 59, a French Ismaili who's a director of the fund.

Aga Khan Fund

Its companies currently employ 30,242 people, he says. The Canadian car dealerships are a legacy from the 1980s, when the fund helped Ismailis settling there, he says. Poonawala declines to disclose the fund's profits, citing its status as a private company.

The Aga Khan owns all but seven of the fund's 175,000 shares, according to the Registre du Commerce in Geneva. The fund is the economic arm of the Aga Khan Development Network, which also has units covering culture and social development projects such as schools and hospitals. The network employs 20,000 people.

The Aga Khan, who travels the world in a Bombardier Global Express jet, declines to comment on how much of the money for his philanthropy comes from his own personal wealth and how much from followers.

``I've never discussed my personal income, and I wouldn't do that,'' he says. ``Every generation of the family has made its investments, and fortunately, some of them have been very, very good indeed.''

Money Laundering

In ``The Memoirs of Aga Khan,'' published by Cassel & Co. in London in 1954, the present imam's grandfather wrote that he kept a ``small fraction'' of his followers' offerings for himself.

Lack of transparency got an Ismaili leader into jail in the U.S. On May 18, 1987, Nizamudin Alibhai, an Ismaili community leader in Texas, boarded an American Airlines flight from Dallas-Fort Worth Airport to London's Gatwick Airport with $1.1 million stuffed in a burgundy flight bag.

Prosecutor Stewart Robinson said Alibhai took $27.3 million out of the U.S. on a total of 33 journeys, breaking a law requiring transfers of more than $10,000 to be declared. Alibhai was charged in Dallas with money laundering for five specific transatlantic journeys, in which he took a total of $4.3 million to London from 1985 to 1987. He was sentenced to seven years in prison.

`Secret Religious Duty'

Alibhai's lawyer said he was performing a secret religious duty. In his memorandum in support of the motion for a reduction of the sentence, defense lawyer Vincent Perini wrote, ``A history of persecution by repressive African governments and fundamentalist Muslim groups have required the Ismailis to keep their activities private.''

The cash was deposited in London because there were no reporting requirements in the U.K. at the time, Perini wrote. His memorandum also included a letter dated March 8, 1990, from Fried, Frank, Harris, Shriver & Jacobson LLP, the imam's Washington-based lawyers, which said the Aga Khan had set up a U.S. bank account for Ismaili tithes following the trial.

``Our client does not direct or control the system of offerings,'' the letter said. ``The contributions, and their collection, have always been conducted by volunteers. These offerings are then primarily used by the Aga Khan to support religious activities and to support a multitude of development projects in the third world.''

Funding Sources

The Aga Khan's followers are unable to answer detailed questions about the sources of funds for their projects. Sher Lakhani, a Canadian Ismaili manager of Geneva-based Aga Khan Education Services SA, doesn't know the breakdown of the $20 million used to build a high school in Mombasa on Kenya's coast.

Mahmud Jan Mohamed, Nairobi-based managing director of Serena Hotels, doesn't know how much of the $19.3 million plowed into the Kabul hotel in the Aga Khan's name came from the imam and how much came from Ismailis. ``All I know is, construction has never been stopped for lack of funds,'' says Mohamed, 52, a Kenyan Ismaili.

Some of the money for the Aga Khan's projects comes from grants and loans from Western governments through organizations like the U.S. Agency for International Development. In 2004, the Aga Khan Foundation, which kick-starts health, education and rural development projects, got commitments of $71 million from donors like the U.S. government, says Tom Kessinger, 64, the foundation's American general manager.

World Bank, Blackstone

``The staff is among the most qualified in the region,'' says Dwight Smith, USAID's assistant mission director in Kenya. USAID granted $35 million to the Aga Khan's projects in Asia and Africa from 1999 to 2004, says Harry Edwards, a Washington-based spokesman for the organization.

The Aga Khan's companies borrow from commercial and development banks and raise funds from investors. In 2003, the World Bank's International Finance Corp. unit lent $7 million to help build the $36 million Serena Hotel in Kabul.

Development funds owned by the Norwegian and Dutch governments also invested $5 million each in the hotel. In April 2005, Afghan mobile-phone company Roshan got $35 million from the Asian Development Bank, which is owned by a group of Asian governments.

Commercial partners include Blackstone Group LP, which is raising the world's biggest buyout fund. In Uganda, the Aga Khan's Industrial Promotion Services is planning a $500 million hydroelectric dam with Blackstone's Sithe Global Power LLC, a New York-based power producer.

Risk Protection

Sithe Vice President Jason Oliver says the Aga Khan's philanthropic reputation protects them from political risks. ``If you just had a U.S. power producer coming in on its own, there wouldn't be as much interest in the deal coming off well,'' Oliver says.

In Afghanistan, the Aga Khan's partners include a company controlled by Bracknell, England-based Cable & Wireless Plc, which owns 37 percent of Roshan. The Afghan cell-phone company has raised more than $160 million of loans since 2002, with $24.5 million coming from the Aga Khan Fund for Economic Development, says Altaf Ladak, Roshan's chief marketing officer.

Roshan has 600,000 customers and 500 employees. The company is profitable, says Chief Executive Officer Karim Khoja, a Canadian Ismaili. He won't say how much it earned on sales of $93 million in 2004.

In remote tribal areas, where women traditionally wear head-to-toe burqas and aren't allowed out of family compounds, Roshan has found a way of boosting its sales and helping vulnerable women with no male relatives: The company uses them as sales representatives, selling them prepaid phone cards to sell to other women.

After the Taliban

``If we had 50 companies like Roshan, we would have a solution to the drug problem, as we would raise professional standards and boost jobs,'' says Ashraf Ghani, 56, chancellor of Kabul University and a former finance minister. Afghanistan is the world's largest producer of opium.

Since the fall of the Taliban in December 2001, the Aga Khan Development Network has channeled $380 million into Afghanistan, home to more than 300,000 Ismailis. Of that, $145 million came from the Ismaili imamate, and the balance came from donors, lenders and other investors in the Aga Khan's companies.

The network fed 500,000 during a drought in 2002; built three bridges, 12 health centers and 26 schools; and repaired cultural sites including the mausoleum of former Afghan king Timur Shah in Kabul, says Mawji, the Kabul representative. It has also extended 6,400 microloans to farmers and traders and trained 189 midwives and doctors.

Kenyan Newspapers

The Aga Khan's first company in the developing world was in Kenya, where he spent part of his childhood. In 1960, he set up Nation Media Group Ltd., a newspaper publisher in Nairobi. ``African political parties were coming into existence,'' the imam says. ``Communication about the thinking that was taking place amongst African leaders and communicating to the African, in a sense, electorate, was something which was really essential.''

Today, the company is publicly traded, with a market value of about 13 billion Kenyan shillings. Nation Media had sales of 4.8 billion shillings and a profit of 641 million shillings in 2004. The company has grown in a region where there are frequent challenges to press freedom, says Dennis Aluanga, the company's finance director.

Nation Media is one of 16 Kenyan companies in which the Aga Khan's fund for economic development owns stakes. The others include Frigoken, the bean exporter, and the Kenyan unit of Serena Hotels, Tourism Promotion Services Ltd., which is also listed on the Nairobi Stock Exchange.

Beyond Companies

The Aga Khan says his mission goes beyond starting companies. ``Countries that have weak health systems, weak education systems, weak financial systems are countries that in 10, 20 years are going to be marginalized by global forces,'' he says.

In the coastal Kenyan city of Mombasa, the Aga Khan Madrasa Resource Centre provides training and support to pre-school teachers in poor Islamic communities. The program was started in 1986 when Sunni Muslim leaders complained that their children were falling behind in Kenya's schools, where English is the language of instruction.

The Sunni children were attending Islamic preschools where they were taught the Koran in Arabic and Swahili, says Najma Rashid, 41, the Sunni Muslim director of the resource center. That left the children at a disadvantage when they entered English-language state schools. The resource center trains teachers of English.

Preschool

In Majaoni, a village north of Mombasa, teacher Zenab Yusuf sits on the floor of her classroom, which is decorated with nursery rhymes and stories about Muhammad written in English.

Her class of 3-year-olds, which meets behind the village mosque, sings in English for a visitor: ``One little, two little, three little Muslims, four little, five little, six little Muslims. . .''

On the other side of Mombasa stands a $20 million school built out of white coral-rock bricks and modeled after Andover, Massachusetts-based Phillips Academy, whose alumni include U.S. President George W. Bush and the Aga Khan's son, Prince Rahim.

Religion isn't even part of the syllabus at the school, which opened in 2003 and has 525 students, ages 5 to 19. ``We'll cover that ground in personal and social development classes,'' Lakhani, 56, says.

Afghanistan to Mozambique

Fees at the academy are $2,700 a year -- more than double the average Kenyan's annual income. About 20 percent of the students will be on scholarship, Lakhani says.

The Aga Khan plans to build 17 more such academies from Afghanistan to Mozambique. He says the schools will help develop African and Asian leaders who can propel their countries to prosperity in the future. ``I'd like to see many more universities in the Islamic world, more schools, many more teaching hospitals,'' he says.

The Aga Khan also needs to prepare the next leader of the Ismaili sect, who is to be named in his will. The Aga Khan has two sons from his first marriage: Prince Rahim, 34, a director of the fund for economic development, and Prince Hussain, 31, who works on cultural projects.

Another candidate is the son from his second marriage, Prince Aly Muhammad, 5.

A male has always held the title, though some Ismailis are debating whether tradition can be broken so Princess Zahra, 35, the Aga Khan's daughter, can inherit the title.

`More Trust'

She is the most visibly active of the children, working with the Aga Khan's schools and hospitals, Lakhani says, in addition to running his personal interests in racehorses.

Such a choice would be risky. ``She would be the best, but then we would have every single Wahabi on our backs,'' says Aly- Khan Satchu, an Ismaili who lives in Mombasa. Wahabism is the puritanical version of Islam that's dominant in Saudi Arabia.

No matter who the Aga Khan's successor is, he -- or she -- will face the same questions about transparency and requests for financial disclosure.

``It's in their interest to generate more trust and be more successful in the future,'' Transparency International's Brooks says.

The future is Orange

 Kenya

The future is Orange

Nov 24th 2005 | NAIROBI
From The Economist print edition

Old tribal divisions trump a proposed new constitution

EPA

Oranges beat bananas

FOR months, Kenyans had pored gamely over the 200-page draft of a new constitution put forward by President Mwai Kibaki's government. This week, after a furious national debate, Kenyans rejected it by a decisive 57-43% margin, so they are left with the same old document the departing British bequeathed them in 1963.

It was largely a protest vote against Mr Kibaki. It certainly leaves his authority diminished—which, ironically, is rather what he said he was campaigning for all along, proposing a new post of prime minister. But, more dangerously, the debate sharpened old tribal and regional grudges, polarising the country between “Bananas” (yes) and “Oranges” (no), the symbols used to help illiterate voters. MPs punched each other in the face and at least 24 people were killed in protests, some shot dead by the police at rallies. The cabinet split so bitterly, with seven ministers joining the opposition campaign, that it has hardly met since July.

Mr Kibaki, the lead Banana, spent a lot of state and other money promoting the new constitution. He bought off key tribal constituencies with land grants, new district boundaries, concessions to sugar farmers and so on. In the end, he had to rely almost entirely on his Kikuyu tribe, the biggest in the country, for the yes vote. To Mr Kibaki's credit, the poll was fairly clean and peaceful, and he conceded defeat quickly and graciously.

The Oranges were savvier. They borrowed a British company's advertising slogan, “The Future Is Orange”, and convinced voters in western Kenya, on the coast and in the Nairobi slums that in fact Mr Kibaki was pushing for a still stronger presidency and more central control that would make the Nairobi elite and the Kikuyus more dominant. Areas of the country inhabited by the Luhya, Luo, Kalenjin and Kamba groups overwhelmingly voted no.

The big Oranges—Raila Odinga, a leading Luo from western Kenya who is the roads minister, and Uhuru Kenyatta, a son of the founding president—are now well-placed for a tilt at the presidency in 2007. Mr Kibaki had promised to fire Mr Odinga, and the other cabinet ministers who defected to Orange, in the event of a Banana victory. Instead, two days after the referendum vote, he sacked his entire cabinet.

Messrs Odinga and Kenyatta are awkward bedfellows, both ambitious and both wishing to give their rival supporters a bigger piece of the pie. The problem is that the Kenyan pie, never large enough, is getting smaller. Economic growth of 5% this year, and the same projected for next, will not match the country's population growth; Kenya may have more than 40m people by 2015, up from 3m a century ago, 9m at independence and 32m or so today. As much as anything, this week's message to Mr Kibaki was that a better constitution might be nice but the people would prefer the more mundane things he originally promised them when he was elected in 2002: more jobs and less corruption.

Kellogg on Branding

 Brands and branding

The last word

Nov 24th 2005
From The Economist print edition

Kellogg on Branding By the Kellogg School of Management. Edited by Alice M. Tybout and Tim Calkins. John Wiley; 334 pages; $29.95 and £18.99 Buy it at Amazon.com Amazon.co.uk

THE Wall Street Journal/Harris Interactive ranking of the world's best business schools is unique in that it is based solely on the views of recruiters, the companies that employ the schools' graduates. It is also unique in that it asks recruiters for their opinions of the various schools' different academic disciplines, including finance, strategy and marketing. In some of these categories, individual schools stand head and shoulders above their rivals. This year, for example, Harvard Business School received more than five times as many accolades for strategy as did the runner-up in the category.

But in one category there is a business school that stands head, shoulders, torso and trunk above the rest. The Kellogg School of Management, part of Northwestern University near Chicago and named after John L. Kellogg, son of the founder of the cereal company, is the world's leading academic authority on marketing—by miles and miles. In the Wall Street Journal poll it received 1,304 accolades for its excellence in this discipline. Its nearest rival received a mere 123 nominations; Harvard 89.

So a book with the title “Kellogg on Branding” arouses high expectations. And this collection of essays, written by professors and other academics associated with the school, does not disappoint. Branding is a powerful weapon in today's marketing armoury; it can lift an indifferent product to cult status and high margins. The book defines it as “a set of associations linked to a name, mark, or symbol associated with a product or service—a brand is much like a reputation”. It is the difference between a Harley-Davidson and A.N. Other Bike. Water is merely a fungible commodity until it becomes a brand in a bottle. There is no shortage of books giving advice on how to weave this particular business magic. If you have time to read only one of them, make sure it is this one.

The book is rich in stories, recounting, for example, how close the BlackBerry mobile communications device came to being prosaically called PocketLink, and how Procter & Gamble dangerously let go of its White Cloud brand of toilet tissue. It is also rich in insights: showing how companies that are successful at branding are either a house of brands—like Nestlé, which owns some 8,000 of them—or a “branded house”, like Dell or the Virgin Group, where everything produced by the firm carries the same name.

There is a description of what it takes to shift brand names from our short-term memory (where they live perilously, always in danger of falling out) to our longer-term memory, where they are more likely to stick, to be called upon later. There is a chapter on branding services, “where the frontline employee is the brand for the customer”; branding technology and valuing brands. And there are short chapters by practitioners, marketing folks in real companies who tussle with the issues of branding day in, day out.

There is also an intriguing chapter by an anthropologist, John Sherry, who describes a brand as “a mental shortcut that discourages rational thought, an infusing with the spirit of the maker.” Some are so infused that they have brands literally branded on their skin, carrying tattoos of their totem products—be they Apple's iMac or a Gibson guitar.

One criticism of the book, and indeed of the Kellogg school itself, is that it is not an international brand. Although BMW and Richard Branson, the founder of the Virgin airline, get a mention, the book's examples come predominantly from America—as do its authors. But branding is an area of business where Europeans compete full-on with Americans. Think only of Gucci, Porsche, L'Oréal and Johnnie Walker. It would enrich the next edition of the book if its editors were to call upon at least one non-American author.

Kellogg on Branding.
Tim Calkins
John Wiley; 334 pages; $29.95 and £18.99

What next for Kenya?

Now that President Kibaki has dissolved his cabinet and prorogued parliament after the disastrous referendum results (fifty seven to forty three against), what happens next?

 

The odds are that the President will dig in and announce a new cabinet composed of loyalists from the Mount Kenya region, and wait out the storm till the general elections in December 2007.

 

That would be true to form

Prodi sfida l'Economist: lo smentirò con i fatti

26 novembre 2005

Le notizie del Corriere via SMS: invia NEWS al 48436.

Il Professore alla casa dei fratelli Cervi evoca una nuova Resistenza

Prodi sfida l’Economist: lo smentirò con i fatti

«Bei tipi, criticano ora il nostro governo futuro»

DAL NOSTRO INVIATO

GATTATICO (Reggio Emilia) — Rieccoli, gli inglesi. E rieccolo il Romano Prodi in versione presidenza Ue, elmetto e artiglio affilato, come quando volavano stracci tra Bruxelles e la stampa d’Oltre Manica. Venerdì di neve e fango tra i pioppeti della Bassa Reggiana, ma al leader dell’Unione basta un attimo per scaldare imotori: «Bei tipi—sbuffa —, criticano l’attuale governo, poi però già immaginano che anche quello futuro sarà piuttosto cattivo, ma che aspettino, suvvia...».

Romano Prodi (Graffiti)

I «bei tipi» sarebbero quelli dell’Economist, che, fatto il funerale alla dolce vita italiana, pronosticato un inevitabile declino per il Bel Paese e spedito dietro alla lavagna il governo Berlusconi, hanno rifilato una sorta di bocciatura preventiva anche a un eventuale governo dell’Unione. Il Professore sfodera il sorriso dei giorni peggiori, assicura di «non essere per nulla irritato o offeso », ma intanto agli inglesi rende pan per focaccia: «Li smentiremo con i fatti. Ho il callo a queste critiche, ne hanno rivolte tante, con insistenza, alle istituzioni europee».

Fine del duello. Anche perché non è certo per parlare di inglesi che il capo dell’Unione è arrivato fin qui, a Gattatico. C’è una vecchia casa colonica in mezzo a questi campi, un tassello di storia italiana: la casa-museo dei sette fratelli Cervi, trucidati dai nazifascisti il 28 dicembre del ’43, simboli di una Resistenza che Prodi non si limita ad esaltare («È sul sacrificio di queste persone che si fonda la Repubblica italiana»), maattualizza («È nostro dovere mettere insieme tutte le radici che hanno liberato il Paese dall’oppressione »), chiamando l’Unione alla «compattezza» e ricordando che «i partigiani non hanno aspettato gli eventi, ma li hanno cavalcati».

Parole che sembrano quasi evocare una sorta di Nuova Resistenza. Ma il Professore non lo dice. Tanto ci pensano due partigiani a chiarire il concetto. Uno «rosso», Giacomo Notari dell’Anpi, e uno «bianco», Romolo Fioroni dell’Alpi. Il primo denuncia «l’oblio» in cui si sentono relegati i protagonisti di quella stagione. Il secondo ricorda che ora l’obiettivo è uno solo: «Mandare via da Roma quelli là». E qualsiasi riferimento al Cavaliere è puramente voluto.

È solo in apparenza un pomeriggio di commemorazioni. C’è l’Italia di oggi, la battaglia ingaggiata dall’Unione contro la riforma della Costituzione voluta dalla Cdl e un’implicita risposta ai recenti attacchi sferrati da Berlusconi ai comunisti, nelle parole di Prodi che celebrano «il valore e la modernità della Resistenza». E quando qualcuno gli chiede qual è il percorso per arrivare finalmente ad una riconciliazione nazionale, il Professore risponde così: «Va compresa la sofferenza di tutti, ma non vanno confuse le scelte di libertà con scelte diverse».

Francesco Alberti

Junction Mall Nairobi

When Nakumatt Holdings opened a store at the Junction Mall on Ngong Road, few would have expected it to be an instant hit.

By Karauki Njeru

When Nakumatt Holdings opened a store at the Junction Mall on Ngong Road, few would have expected it to be an instant hit.

But, to the surprise of everyone in the real estate industry, Nairobians literally shopped at this store ‘till they drop.’

Indeed just like the Nakumatt store on Prestige Centre, shoppers seemed not to mind the busy construction that was going all around them as they opened their wallets to pay for their Christmas shopping.

As the Junction Mall nears its official full opening date in April, so is the complete mosaic of the emerging shopping experience in upper class Kenya taking shape.

With the opening of the Junction, the mallification of Kenya is taking shape. The recent proliferation of shopping malls from all around the city is now being taken to represent a collective physical expression of our society’s desire to shop.

Though Nakumatt risked cannibalising its existing store on Ngong Road, Ben Woodhouse, the General Manager, of Knight Frank Kenya, says the possibility of this supermarket being sandwitched between two Uchumi outlets offered an ever worse prospect. That is why Nakumatt jumped at the opportunity to open a store here when Uchumi Supermarkets did not show enthusiasm.

In the last 10 years, three major shopping malls have opened in Nairobi following suburban shift of the Nairobi office market.

"A trend towards decentralised retail provision in Nairobi has led to the old prime pitches of Moi Avenue and the area between Kenyatta Avenue and Mama Ngina Street becoming less popular with the chain retailers," says Woodhouse. "However, the city centre still remains a thriving central location for the smaller scale general trader."

According to Woodhouse, traffic congestion in the CBD and fears over security led to the shift in the early 1980s towards suburban shopping centres, starting with the construction of the first phase of Sarit Centre in Westlands in 1983.

Sarit today is Kenya’s biggest shopping mall with 215,300 square feet of shopping space. The Village Market in Gigiri is the second biggest. Both centres are expected to suffer from increasing traffic congestion and insufficient parking space.

Woodhouse says that the most significant retail development in recent years has been the Capital Centre (122,200 sq ft) on Mombasa Road that is anchored by Uchumi Supermarkets, which has rented nearly half of the space. Capital Centre opened its doors to the public in May 2003.

While The Junction Mall is now the third biggest in Kenya, it is uniquely located in such a way that it could steal valuable traffic from the Yaya Centre and Sarit Centre. The inclusion of Nakumatt as the anchor store now lumps a significant volume of shopping space (over 100,000 square feet of prime retail outlets) in Nairobi on Ngong road, making it one of the most important commercial centres in suburban Nairobi.

Unlike the past where South African retailers have struggled to make significant inroads into the Kenyan market because of their reluctance to pay huge rents, Knight Frank has convinced Stuttafords to take 22,000 square feet. Stuttafords is a major fashion clothes departmental store in South Africa.

With two major anchor stores, Knight Frank’s main worry is to generate enough footfall to generate a good return on this Sh700 million investment (which has been financed by Actis among others).

"It is the first time in Kenya that a lot of thought has gone into enhancing the shopping experience," says Woodhouse. "There are no dark corners where a client is going to pay for less money." The mall features spacious atriums, landscaped grounds, over 400 parking spaces and 30 prime retail outlets. The flow of traffic has also been designed in such a way that shops can be able to convert traffic into revenues.

A lot of attention went into selecting the tenants of the mall. The mall will feature a dedicated media and entertainment centre complete with a modern bookstore with a Dorman’s Coffeehouse inside and a four-screen multiplex—in addition to the two others at Prestige Centre.

Java House is also relocating from Adams Arcade to the Junction.

"We chose our clients carefully so that we cater for the different needs that the clients are looking for," says Woodham.

"We have been impressed by the manner in which our clients have worked to look presentable to the shoppers and the kind of reception the customers have given us is very promising."

While all this may look excess in the face of a recovering economy, the shopping patterns in Nairobi appear to be telling a different story.

The shopping malls have become a very popular with many young middle class Kenyans looking for efficiency and convenience that comes with the increasingly busy lifestyle.

Retails and property developers have taken the cue and manufactured what would be rightly called the shopping psychology with displays, offers, lighting, and beautiful packaging that leaves the shopper with the urge to buy as many items as their hands can carry.

The shops are strategically placed to lure the customers into the diverse range of goods and services. "We look into providing a variety of shops that complement each other," says Nitin Shah, the Managing Director of Sarit Center.

"When we opened the Sarit Center in 1983, we thought that the Kenyan shoppers would jump into the shopping mall idea but on the contrary it took a while for the traditional shopper to embrace the idea," adds Shah.

My career International Real Estate Stocks

The Timing Is REIT for Germany
[March/April 2005]

By Theodore Murphy

The global property investment community received good news this January when a German official announced that there could be a REIT market in Europe's largest economy by the start of 2006.

"The Finance Ministry is in favor of introducing real estate investment trusts in principle," said Germany's Deputy Finance Minister Barbara Hendricks in a Jan. 19 statement. "We expect that the introduction of German REITs will strengthen Germany as a financial center and the German real estate industry in a lasting way and can make Germany the leader in real estate investment in Europe."

Indeed, Germany's real estate investment profile suggests that the introduction of a REIT structure could be a step in the right direction for this market valued by real estate advisory firm DTZ at €1.2 trillion ($1.6 trillion U.S.). The bulk of commercial real estate assets in Germany are in corporate hands. The remainder is mostly owned by German open-end real estate funds, which attract very little international institutional capital and are beset by structural liquidity issues.

The German property market has been in the doldrums for the last five years. In a stagnant economy, with minimal growth, rising inflation, and a fast aging population, Germany's fragmented markets have generally floundered across all sectors, with rents sliding and vacancy soaring. Indeed, the introduction of REIT legislation is just one of the pieces required to complete the German property market puzzle.

"It is a step in the right direction," says William Hauser, a New York-based portfolio manager for HVB Capital Management, Inc. "But the fundamentals are still not there."

Liberate the Capital

Moving company-owned real estate to listed REITs may allow German corporations to free up investment capital. "Some 70 percent to 75 percent of commercial property assets in Germany are held on corporate balance sheets compared with approximately 50 percent in the U.K. and 25 percent in the U.S.," says John Gellatly, London-based director of real estate investment banking at Credit Suisse First Boston.

At a time when unwieldy conglomerates have fallen out of business vogue and agile specialists with svelte balance sheets are held up as models, the option to spin real estate departments off into subsidiary REITs could be very appealing to Germany's corporate giants.

"We are watching the situation very carefully and may decide to make a move if the legislation is right," says Marion Ringling, spokesperson for Munich-based Siemens Real Estate, the real estate branch of Siemens AG which owns and manages some 68.9 million square feet around the world, with a book value of a2.8 billion ($3.7 billion U.S.).

Invite Some Friends

Germany's property management companies and open-end real estate funds may attract more foreign and institutional investors if the government introduces REITs. Currently, the German property market ranks last proportionately in Europe as a destination for international capital, with only 5 percent to 10 percent of the country's assets held by international investors, according to Martin Becker of the Real Estate Finance Department of the European Business School.

U.K. Update Last spring, in the wake of REIT-friendly pronouncements by Gordon Brown, Chancellor of the Exchequer (U.K. equivalent of U.S. Secretary of the Treasury), few observers would have expected that Germany would create a REIT structure before the U.K. However, with elections expected in May 2005, progress this year on REIT legislation shifted down the list of priorities. "I think the property industry in the U.S. got wildly excited last year, and then wildly disappointed," says John Gellatly, London-based head of real estate investment banking at Credit Suisse First Boston. Nonetheless, Gellatly, who represents the U.K. real estate industry in informal talks with the government, says that the government is commited to REITs and expects to see progress soon. "We expect to see a policy document [before the end of March]," he says. "I have been told it will have a combination of hard legislative proposals as well as some areas open for discussion. We're not quite yet at a statement of political intent. But if we get a positive policy document," he says, "we'll only be three months behind Germany. Suddenly, everyone will say, ‘Wow, that's great.'"

"There is no money going into Germany because international institutional investors prefer to invest indirectly through a vehicle. They don't like the current open-end funds, which many consider too diversified," says Becker, whose department has conducted REIT feasibility studies at the request of the Finance Ministry. German open-end funds typically hold assets in multiple property sectors, whereas REITs tend to specialize in just one. "The REIT vehicle could give them the focus they want," he adds.

The biggest beneficiary of a REIT structure could be Germany's embattled open-end real estate fund market. The essential mission of Germany's open-end funds is similar to that of U.S. REITs: to allow retail investors to invest in large-scale commercial real estate.

The term open-end derives from the fact that the fund continually creates new shares on demand. Investors buy the shares at net asset value (NAV) and can redeem them at any time at the prevailing NAV. The structure has been around since the 1950s and has played a vital role in mobilizing the resources of a population that did not have a tradition of equity investing. The sector benefited from large inflows in the wake of Germany's stock market slide in 2002, as investors took shelter in what they saw to be more tangible assets than those offered on the stock market. According to BVI, the German fund management association, at last year's close the open-end real estate fund market was valued at €87.2 billion ($113 billion U.S.).

At the time of Hendricks' announcement, worry over the health of the open-end fund market was at a peak. At the heart of the disquiet is a case brought by a Frankfurt public prosecutor last September against Deka and DB Real Estate, two of Germany's largest funds, accusing some executives of accepting bribes in exchange for acquiring properties at inflated prices.

Making matters worse, BVI released a statement that showed €653 million ($853.2 million U.S.) had flowed out of open-end real estate funds in the fourth quarter of 2004. If confidence is further eroded, more investors may want out.

Transition Dynamics

What form REIT legislation in Germany might take is yet unclear. Key issues concern whether development restrictions and mandatory listing will be in place, as in France.

"We are hoping for the most liberal structure possible," says Immo von Homeyer, spokesperson for IVG, the largest company in Germany's small listed real estate sector. IVG, like most of the other listed property companies and many of the larger corporate real estate departments in Germany, has a development branch.

The German government's public embrace of the REIT concept comes 18 months after the first French company adopted a REIT-like tax transparency structure. According to Alec Emmott, director of Société Foncière Lyonnais, the SIIC (Sociétés d'Investissements Immobiliers Cotées—French REIT equivalent) structure did wonders for the French listed property sector.

"The listed sector in France was down on its knees two years ago, because we were all listed at a discount to NAV and breakup value. One-by-one we were being picked off by opportunity funds, breakup artists," he says. "If something hadn't changed I think the sector was in danger of ceasing to exist."

Since the adoption of REIT legislation, the French listed property sector's market capitalization has nearly doubled, boosted not only by rising valuations of existing listed players but also by new entrants from home and abroad.

---

Theodore Murphy is a New York-based freelance journalist and the U.S. correspondent for Real Estate Europe.

 

 

 

Offshore real estate stocks, regarded as a safe haven during the global bear market of three years ago because of their high income yields, are being spurned by investors in favour of general equities

Offshore real estate stocks, regarded as a safe haven during the global bear market of three years ago because of their high income yields, are being spurned by investors in favour of general equities.

Three years ago, offshore listed property stocks won this beauty contest hands down. Since then their income yields have halved to 4.5%, while dividend yields on general equities have more than doubled to 7%.

The same is not true of JSE-listed property funds, many of which still offer attractive yields of 9% or more. The reason for this is that South Africa is still in an interest rate down-cycle, while most of the rest of the world has had to raise interest rates to curb inflationary pressures.

Many European countries are now contemplating following Sweden's recent example of lowering interest rates again, or at least capping rates at current levels. SA's benign inflation holds further scope for rate cuts in the weeks ahead, which have helped push property stocks to record highs in recent months.

Offshore it's a different story. Rising interest rates have taken some of the sheen off real estate stocks, while general equities, despite price rises of between 36% in the US and 50% in the UK since early 2003, now offer dividend yields comparable to that of the JSE.

Overseas equities now offer better returns than listed property, according to Ian Anderson, fund manager for Marriott's International Real Estate Fund and its balanced fund, the International Income Growth Fund.

"In 1999, the earnings yield on listed property in the US and the UK was 5% more than that provided by equities. The situation has now reversed, with equities delivering 2% better earnings yields in the UK than listed property," says Anderson.

Marriott recently capped its International Real Estate fund, recommending that investors switch their offshore exposure to global equities.

"This fact is remarkable considering the relative high-risk profile of equities versus listed property, but the reason is that global equities are well priced," adds Anderson.

"The earnings yields on global equities have returned to the level they were before the heady days of the late 1990s. They were 7% before this bull run, fell to 3% by 2000 when the run peaked, and are now back to 7%. This demonstrates excellent value for our investors."

Anderson says the Marriott International Income Growth Fund is now 70% weighted in equities compared with 45% two years ago. Its property weighting is 10% today, down from 30% at that time.

"Anyone who invested in international real estate before this surge in prices has done well. Our fund produced positive returns every year in spite of our local currency's volatility in the past six years.

"But we're now advising our clients to move to equities," says Anderson.

A consensus is forming that international real estate is now showing symptoms of distension.

Tony Gibson, executive chairman (international), Coronation Fund Managers, says the 20-year decline in interest rates has created a fertile environment for real estate investing.

Housing affordability has closely followed the trend in the 10-year Treasury bond yield.

The number of new houses for sale in the US for which construction has not yet begun is at an all-time high, evidence of speculation run amok.

"This is a particularly precarious situation at this juncture, since homeowners' ability to meet their mortgage obligations is alarmingly stretched with a high ratio of mortgage debt to homeowners' equity," says Gibson.

Business Times

nternational fund managers looking to SA’s listed property sector for investment opportunities

Nick Wilson

Property Correspondent

AS THE market capitalisations of listed property companies grow and trading liquidity improves, international fund managers should start looking to SA’s listed property sector for investment opportunities.

This is the view of Steve Buller of Fidelity Investments in Boston, US, who was delivering a presentation on international listed property trends at the Stanlib International Investment Conference held in Sandton yesterday.

Buller, Fidelity’s group leader of real estate securities and portfolio manager of a variety of real estate securities, said that SA was "about to be (put) on the map" as far as international investor awareness was concerned.

He said there was "very little" foreign ownership of listed property stock in SA, while in other countries foreign ownership was increasing.

But this could change as market capitalisations and trading liquidity of South African listed property stocks improved.

Buller said listed property was a popular asset class on the global stage and that there had been growth in the market capitalisations of listed property stocks throughout the world.

He expected this trend to continue, especially with the introduction of the Real Estate Investment Trusts structure pending in 15 countries. Listed property unit trusts are SA’s equivalent.

Buller said that in 1980 only 2% of all commercial property in developed countries was listed on stock exchanges. "Now it’s 11% and growing. We are going to see more and more properties being listed."

Colin Young, property sector head at Old Mutual Asset Management, said it was an "exciting prospect" that foreign investors would be interested in SA’s listed property sector.

Young said that in an environment where the rand was stable and attractive forward yields were on offer, it was understandable that foreign investors would look at SA’s listed property sector.

"Size and liquidity still need to be improved on. Taking a global view, our market capitalisation is still small."

Young said corporate governance in SA’s Africa’s listed property sector the would also have to improve and that there was a need for more property entrepreneurs to enter the sector.

"Investors are not the constraint (for growth of the listed property sector). The number of retired people is growing because people are living longer. There is hungry demand for income-type products like property," said Young.

 

From nareit.com

 

By Phil Britt

In a year when caution was urged, real estate mutual funds again outperformed, topping 30 percent total returns in 2004. But can portfolio managers maintain that pace in 2005?

Total return expectations for the publicly traded real estate industry heading into 2005 looked very similar to the conservative outlooks taken by analysts and fund managers prior to the start of 2004, a year that turned out significantly better than what was originally forecast. While 2004 was expected by many to see a sharp slowdown in REIT returns, NAREIT's Composite REIT Index was up 30.41 percent and NAREIT's Equity REIT Index rose 31.58 percent for the year.

		Real Estate Fund Rankings

Not surprisingly, those returns translated into another strong year for real estate mutual funds. According to Lipper's performance rankings for real estate mutual funds, 63 of the 80 distinct funds produced a cumulative total return in excess of 30 percent in 2004. The average total return for all real estate funds in 2004 was 32.05 percent. By comparison, the Standard & Poor's 500 Index was up 10.88 percent while the Dow Jones Industrial Average was only up 3.15 percent.

The top-performing real estate fund in 2004 was the Morgan Stanley Institutional European Real Estate Fund, with a cumulative total return of 47.49 percent, followed by the ProFunds Ultra Real Estate Inv (42.95 percent) and the Cohen & Steers Special Equity Fund (40.98 percent). All three of those funds also ranked among the top eight highest returning funds in 2003.

Looking back at three- and five-year performance results, the story doesn't change for real estate mutual funds. The average three-year annual total return of the 65 funds Lipper tracked during that period was 23.62 percent. The average five-year return (for 54 eligible funds) was 21.41 percent. The top-performing fund, on average, over the past three years was the CGM Realty Fund (38.58 percent). The top-performing fund, on average, over the past five years was the Alpine U.S. Real Estate Equity Fund (32.02 percent).

While the past year and historical returns are worth noting, the challenge of matching, or even approaching, those same results in 2005 is a daunting one for any fund manager. From Dec. 31, 2004 through Jan. 20, 2005, only two of the real estate funds tracked by Lipper produced a positive total return (the Alpine U.S. Real Estate Equity Fund and CGM Realty Fund). While the first few weeks are hardly indicative of full year results, especially for an investment that is intended to be held for the long term, most fund managers expect the industry's performance to slow (even though many feel we could still be looking at low double-digit returns).

What the Future Holds

		International Investments Should Provide Further Bounty in ’05 Funds with international investments, either strictly in foreign REIT-like investments or in U.S. REITs with operations overseas, fared very well in 2004 thanks to the growing appeal of this type of investment, the devaluation of the dollar and properties selling at a discount to net asset value.

When asked what could stunt the industry's total returns, several real estate fund managers cite maturation of the economic recovery, higher net asset value of properties in general and more acceptance of REITs as solid investments in the last couple of years–meaning higher prices for REITs in 2003 and 2004, but leaving less room for growth in 2005.

"In 2005, the watchword is caution. Valuations do not appear to be overly expensive, but they're not cheap," says Joe Rodriguez, lead portfolio manager for AIM Real Estate. "Real estate has outperformed the S&P for five years, so we're cautious."

Steve Buller, portfolio manager of Fidelity Real Estate Investment Portfolio and Fidelity International Real Estate Securities Portfolio Fund, says that because REITs have done so well over the past couple of years, there tends to be the reaction among some investors that they are overvalued.

"In reality they are not overvalued compared to the private market," Buller says.

Buller looks at total return expectations on a more long-term horizon, citing that the next three years could produce annual total returns between 8 percent and 10 percent, with half of that coming from dividend yield. However, Buller does caution that volatility will persist in the REIT market in 2005 and beyond.

Kelly Rush, director of portfolio management for Principal Global Investors, predicts an 8 percent to 10 percent total return for 2005, which Rush says is more in line with historical results than the 20 percent and 30 percent gains in recent years. Rush adds the caveat that an inflation spike could sharply reduce that return expectation.

"We often get asked about a ‘real estate' bubble," Rush says. "Our reaction is that we don't think there's a bubble. A bubble occurs when there's no relationship to fundamental value. While I'll admit that real estate stocks are expensive from a historical perspective, I don't think there's a broad-based, nationwide bubble."

The performance of REITs in 2005 will largely depend on the continued economic recovery, according to James Corl of Cohen & Steers Capital Management Inc., the company's chief investment officer and manager of the company's Realty Shares and Realty Focus funds. Though he says the economic growth will continue, he expects the pace will be slower in 2005, causing REIT returns to be lower as well.

"The key for any REIT stock or any [other equity investment] is what is happening to the earnings growth rates," Corl says. "The economy will continue to fuel the real estate recovery as sure as night follows day."

Sam Lieber, president of Alpine Funds, agrees that REIT returns will largely depend on continued strength in the economy. However, Lieber's not as optimistic about the economic prospects as Corl.

"It's all predicated on the recovering economy and whether the pace is as strong as people hope," Lieber says. "You need to be looking at the rate of dividend growth, which we don't think will be strong for the next two years. REITs may have gotten a little bit ahead of themselves. I don't think REIT stocks will do badly in 2005, but I don't see the 20 percent to 25 percent gains of the last couple of years. Five percent to 10 percent total returns are much more likely. The risk of negative returns is also greater."

Corl points out that many industry pundits were similarly skeptical entering the 2004 year, only to see growth rates continuing to increase on a quarter over quarter basis. His prediction of 18 percent to 20 percent total return for 2004, turned out to be a little conservative as well, though not the 0 percent growth that he said some others had predicted entering the year.

"Beginning in 2003 and continuing in 2004, signs were fairly negative, but the market climbs a wall of worry," Corl says. "Some think we've come too far or that interest rates have gotten too high. I think that's great."

Corl points out that some REITs are still rebuilding value lost in the late 1990s, highlighting 1998 and 1999, when the NAREIT Composite REIT Index was down 18.82 percent and 6.48 percent, respectively.

"The last time we hit an inflection point [changing from increasing to decreasing growth] was in 1998 and the real estate stocks fell as well," Corl says, adding that the change in direction is more important in a REIT's performance than whether the REIT itself is profiting or not. "We're not at peak multiples yet. There's no reason [for REITs] to underperform."

While he doesn't expect the overall direction of growth to change at least for the next couple of years, Corl does expect fund performance to moderate from the 30 percent to 40 percent levels that many funds enjoyed in the last couple of years. Cohen & Steers' own Realty Shares fund was up 40.98 percent in the last year and is up an average of 30.47 percent over the last three years (the fund was previously named the Realty Focus Fund). For 2005, a total return of 14 percent to 15 percent, 9 percent to 10 percent from capital appreciation and the rest from dividends, is much more likely, according to Corl.

Lieber points to some cautionary historical data. Historically, two-thirds of a REIT's total return has been in the form of dividends. But with the run-up in REIT prices over the last two years, dividends now reflect only about one-third of the average REIT's total return. If that were to drop back to the historical average, a REIT's total return would drop to about 7 percent, with only 2 percent to 3 percent from appreciation.

Short-term cautions aside, Rodriguez stresses that REITs are a long-term investment proposition and says he expects real estate funds to outperform other equities for at least the next five to 10 years.

Even though he doesn't expect 2005 to match the 2004 returns, the real estate market still has legs for the next couple of years, according to Corl. So he expects 2006 and 2007 to follow 2005 with solid returns.

"These investments aren't at their peak multiples yet," Corl says.

Sector Plays for '05

		Scudder Leads the Pack in a Solid Year for Closed-end Funds In addition to the outstanding year for open-ended funds, closed-end real estate funds posted another solid performance in 2004, according to figures from Lipper. A pair of Scudder funds set the pace, with returns of 36.79 percent and 35.79 percent, respectively.

As to specific sectors, Corl likes the 2005 outlook for hotels, apartments and self-storage. Office properties should also offer some good returns—but only in specific parts of the country, particularly in Washington, D.C., Southern California and New York. Other dense urban areas may offer opportunities as well, but in areas like the Midwest where there's little barrier to entry, the returns for office properties will probably continue to be substandard, according to Corl.

In Lieber's view, retail companies with assets in well-located urban markets should do very well in 2005, especially shopping malls. Yet some of the best retail opportunities, Lieber says, may be overseas with the European efforts of Simon Property Group (NYSE: SPG) and Westfield Group (ASX: WDC).

Lieber says he sees multifamily REITs struggling this year, particularly after the soft numbers that Gables Residential Trust (NYSE: GBP) and Essex Property Trust, Inc. (NYSE: ESS) reported near the end of 2004 and their lowered guidance for 2005.

Sector calls have been a key component of the ongoing success Rodriguez has seen from his AIM Real Estate Fund, which has been among the top-performing REIT funds over the one-, three- and five-year periods.

"Over the last five years, we've significantly overweighted regional malls and underweighted apartments," Rodriguez says. "Early in the recovery, we overweighted health care, then we underweighted it later in the recover. Earlier in the recovery, we underweighted hotels, then we overweighted them."

Though Rodriguez still likes regional malls and hotels, as well as office companies focused on New York City, Washington, D.C. and Southern California, investors may have to settle for receiving dividends with little or no equity growth in 2005, he says.

Michael Schatt, senior portfolio manager for the Phoenix-Duff & Phelps Real Estate Securities Fund, is a little more optimistic about 2005 than Rodriguez. Schatt looks for total returns in the low single digits for 2005, with retail and hotels driving the performance.

Whether 2005 total returns will drop back to historical averages won't be known until the end of the year, but most of the fund managers agree that investors expecting the over-the-top returns of the last few years will be disappointed if they expect similar results in the next 12 months.

In its 2005 Market Outlook, Prudential Real Estate Advisors also points to the likelihood of a weaker, but solid 2005, but also says: "The arguments for REITs continuing to perform well are too compelling to rule out another strong year. REITs have weathered the worst of the downturn in the property markets and should see improving operating fundamentals as the market recovery accelerates."

Buller notes that people who were worried about the REIT market a year ago missed out on a good total return, particularly after the April/May correction of 2004.

"REITs are really for long-term investors," Buller says. "If you're only playing REITs for the next six to 12 months, then I don't know if you'd want to invest in this particular group."

 

Real Estate Portfolio recently asked celebrated investment manager and noted bear Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo & Co. LLC, to share his thoughts on the capital markets and REIT stocks.

Portfolio: There's a statue of Buddha in your office. Have you achieved "uncommon wisdom" together, like the tagline of the Wachovia commercials?
Grantham: Well, the statue does carry a subliminal message. I bought it during the last Asian crisis when you could buy used Mercedes-Benzs by the garage-full. Not surprisingly, it was very cheap and it is soothing for me to look at because it was such a bargain, which always gladdens the heart of a value investor.

Portfolio: Speaking of value, you are considered a champion of value investing. How do you define "value" and what is the evidence that it outperforms?
Grantham: We define value much more broadly than most. We pay up for "quality" stocks with high and stable profitability and low debt. Microsoft has been a value stock under our model 80 percent of the time, and Coca-Cola has too, sometimes, which is unusual for value models. The model has worked well for 25 years. Our model returns four points a year above the market before costs when we consider the most attractive 60 value stocks out of a 600 blue chip universe.

For the broad market, value bets have always won in the past—eventually—but the time horizon is uncertain. From year to year, there are plenty of other crosscurrents in the market, but value will usually win in a three to five-year timeframe.

There are other value models that use crude metrics like price-to-book ratios. They only return an extra one percent a year, which is not a great bargain because the stock selections tend to be very junky, low-quality companies. With our broader value, you get a free lunch because you get higher returns without higher risk, a point, I might add, that impresses professors of finance more than our clients.

Portfolio: You have said your thinking is influenced by the presidential election cycle. What is your outlook for 2004?
Grantham: We focus first on value. The presidential cycle is only the cherry on the cake for us. That being said, the fourth year of a presidential cycle is usually pretty calm. That means that the market will not want to go leaping around in 2004. The market is unlikely to collapse even though it is terrifically overpriced and getting more so by the day.

Portfolio: Sounds like you expect ordinary returns in 2004. People have come close to calling you an "eternal bear" and you have said elsewhere that you believe that the market is headed down in 2005 or 2006. You expect the S&P 500 to fall to 700. What will bring on a bear market and what should investors do?
Grantham: The market has gone down in fully half of all the first years of the presidential cycle since 1932. The precipitating factor is housecleaning by officials in Washington. We have very high levels of debt across the board—international debt to finance our deficit and dangerously high corporate and consumer debt. Debt takes away your flexibility.

Presidents want breathing room in year three of the cycle to stimulate the economy to set things up for reelection. There was a huge amount of economic stimulus thrown at the market in 2003—the tax cut, low interest rates, and a huge supply of low cost money to speculate with. Low rates, easy money and moral hazard. The market responded nicely and all speculative categories outperformed—growth, small cap and junk.

In effect, the president and the Fed said, "we will rush to help you, we'll give you a free roll of the dice, underwrite your risk, and make it safe for you to speculate."

Portfolio: The debt overhang was there in 2003 and earnings multiples still expanded. Are you saying that policymakers in Washington intentionally bring on a price-earnings contraction in the first two years?
Grantham: No. They intentionally move to houseclean the economy and an unintended consequence is that the market falls. They want to correct imbalances in the economy and smarten-up balance sheets for reelection. In 2005 and 2006, profit margins are likely to go down and interest rates to go up and, if that happens, the market will go down. It will be a good time to concentrate on value investing and that's what investors should do. The main point about the presidential cycle is that animal spirits rise in years three and four and fall in years one and two.

In the end, it's all about optimism. Average P/E's have been creeping up over time—from 8 to 14 to more than 23 now. People believed in the bear market rally in 2003 mistaking it for a real bull market, but you have to remember that in the long run you spend half the time below trend by definition, and trend is only 16 times.

REITs should play a substantially bigger role in the typical portfolio than is usually suggested. U.S. real estate is an important and different asset class and a very big one.

Portfolio: You have said that REITs have outperformed the market "brilliantly" this last year, but you don't know why. Do you think that high dividend yields on REITs have something to do with it?
Grantham: No, it's not simply the yield because high yield stocks, other than REITs, badly underperformed the market in 2003. And it's certainly not the fundamentals because rents and occupancy rates are weak. So it's a bit of a conundrum. The most likely candidate is that the low interest rates that Greenspan has engineered simply make buildings cheaper to buy with debt.

REITs outperformed from March 2000 to October 2003 through the worst part of the decline in the S&P. They were not in the same bubble as other stocks and it was a no-brainer to buy REITs and underweight the S&P. We placed a huge bet on REITs at the time, making them 9.5 percent of our portfolio, but REITs also outperformed in the rally that came after and that is exceptional. There are very few situations where a type of stock continues to outperform both when the market goes down 50 percent and also when it rallies 30 percent.

I believe the next important leg for the market is down, perhaps after a few more months of a rally, but I expect REITs to outperform once again in the next decline because they are still less expensive than the rest of the market.

Portfolio: So, you view REITs as a defensive play in the coming down market? Your firm's seven-year forecast calls for REIT stocks to return an average 3.8 percent a year while the market will drop one percent a year. The 3.8 percent is on a total return basis, implying that you expect REIT share prices to decline. Why would you hold any stock when you expect the price to go down?
Grantham: Nearly all money managers are held to benchmarks by their clients. They must report how well they are doing relative to the S&P or other benchmark. They often end up saying essentially, "look how well I have done being down only 27 percent when the S&P is down 30 percent."

At Grantham, Mayo, Van Otterloo & Co. LLC, we try to generate interest in absolute return portfolios, ones that actually make money for the client instead of meeting a benchmark. We did not own any regular S&P-type stocks in our absolute return portfolios during the decline, but we did own REITs and still do today.

Portfolio: However, you have said that better defensive plays than REITs are available. What are they and what makes them better?
Grantham: Emerging market equity and debt, international small cap value, TIPS (Treasury Inflation-Protected Security government bonds), and timber. I put them all ahead of REITs, but REITs are on a different cycle so I add them to the mix. It may sound strange to have emerging market equity and TIPS as backbones of a portfolio, but emerging markets will go up 30 percent if the U.S. market hangs in, and TIPS have no risk, which keeps total portfolio risk under control. That's how you build an efficient portfolio—with the highest return for the level of risk chosen.

Portfolio: You also view international stocks as a better defensive play than REITs. Why do you hold this view when international markets now move in tandem more so than before, while the correlations between REIT stocks and the U.S. market have been declining?
Grantham: International stocks are not a better defensive play in all cases. If the market goes up, hangs in, or goes down a little, international wins. If the market goes into a steep decline, REITs win.

Taking all the probabilities together, I'd take international over REITs, but it's better to have them both and that's what we do. We don't get carried away by monthly correlations. We look at multi-year periods. I believe we are at the end of a 10-year period where the S&P won. Before that, international outperformed for eight years. In the longer run, they still move in very different cycles.

Portfolio: Your firm runs hedge funds. Under what circumstances would you short REIT stocks?
Grantham: We're running over $2 billion in 10 hedge funds that follow a market-neutral long-short strategy [achieves constant returns by combining long and short positions to eliminate market risk]. We would short REITs if they doubled against the rest of the market and became splendiferously expensive. But we're nowhere near that now. We won't be shorting REIT stocks for the foreseeable future.

Portfolio: What place should REIT stocks have in the average investor's portfolio?
Grantham: REITs should play a substantially bigger role in the typical portfolio than is usually suggested. U.S. real estate is an important and different asset class and a very big one. REITs are a way to get in, and, at normal prices, investors should own several times the ratio of REIT capitalization to total market capitalization. This is despite the fact that REITs track U.S. small cap value when you look on a monthly basis.

On a longer-term basis, not surprisingly, they track the underlying real estate that is very different to regular equities. REITs are substantially different from regular stocks when you look at longer periods. In accounts where we have to own U.S. equities, REITs are 5 percent to 10 percent of our normal position—more when they are cheap relative to the rest of the U.S. market and less when they are more expensive.

Where we have a free hand, we own 10 percent to 15 percent U.S. REITs and no other U.S. stocks. In those accounts, our REIT position peaked at 23 percent of total portfolio and it's on the way down to 10 percent. Why? It's the fourth consecutive year that REIT stocks have been outperforming and, obviously, that can't continue indefinitely.

Editor's Note: GMO manages funds and separately managed accounts, several of which owned Coca-Cola and/or Microsoft at the time of this interview. References to individual stocks should not be considered a recommendation to buy or sell those stocks.

Investment legend John Bogle pioneered no-load and index mutual funds while heading up The Vanguard Group. His views on investing and mutual fund governance, majestic in their simplicity, have remained remarkably consistent since he first expressed them in his undergraduate thesis at Princeton in 1951. Portfolio recently sat down with Bogle, who says he is now on his third career, and got his big picture insights on investing, the state of the mutual fund industry and how sector investing, including REITs, fit into his overall thinking.

Portfolio: Has the mutual fund scandal been resolved to your satisfaction?
Bogle: We're making wonderful progress, thanks to the SEC and its chairman, William Donaldson. Independent board chairmen have been mandated for mutual funds. Fund manager boards must have a supermajority of independent directors—75 percent. And the SEC has authorized the hiring of staff and the retention of independent experts to provide board members with objective information so they no longer have to rely solely on what management puts in front of them.

Portfolio: What's left to be done?
Bogle: The preamble to the Investment Company Act of 1940 states the ideal that investment companies should be "organized, operated, and managed" in the interest of shareholders rather than in the interest of managers and distributors. But it's very clear that's not how the industry operates. An express fiduciary duty standard for fund managers and distributors to act in the interest of shareholders needs to be written into the law.

Also, it's a disappointment that fund executives are not required to disclose their compensation. Right now, all they have to disclose is the method by which they are compensated. But there's nothing like full disclosure of the numbers to alter conduct. A $37 million compensation figure tends to catch the eye. It's an act of hypocrisy to fight such disclosure while demanding it on the part of corporations whose shares the funds own. In effect, the mutual fund industry is saying, "you tell us your compensation but we won't tell you ours."

Portfolio: Why do you continue to criticize the mutual fund industry with respect to sales loads, fees, marketing expenses, turnover and taxes?
Bogle: Because all of these costs are still too darn high. Gross return minus cost equals an investor's net return. There can be no doubt about what I call the "CMH"—the Cost-Matters Hypothesis. The evidence shows that over the past 20 years, the average equity mutual fund has underperformed the stock market itself by about 3 percent per year—just about equal to their fees, expenses, sales charges and transaction costs—and that an amazing 85 percent of actively managed equity funds underperformed the broad market index in that period. I'll keep right on criticizing the industry until costs come down to reasonable levels.

Portfolio: Has Vanguard succeeded in its mission to be the lowest cost provider of financial services in the world?
Bogle: I try to avoid using the word "success." In business, success is a journey, not a destination. The journey is never over, but I would say we have accomplished the mission. Vanguard's average expense ratio is 0.25 percent, versus an average of 1.25 percent at other mutual fund companies. No one can come close to our expense ratio. That 1 percent savings, on a $750 billion asset level, means that an extra $7.5 billion a year is being returned to Vanguard's shareholders. That's real grown-up money.

Portfolio: What safeguards are in place to ensure that Vanguard will continue to be controlled by its own shareholders and run for their benefit?
Bogle: There is no guarantee that Vanguard will continue to be run in the present mode forever. Structures can be changed. But I'm confident that our directors and shareholders would never let that happen. If they were foolish enough to abandon the existing structure, I would turn over in my grave.

Portfolio: What you say reminds me of Arthur Andersen, who started his accounting firm in response to some early scandals in the accounting industry. It's ironic that his firm blew up in the Enron scandal some decades later.
Bogle: It was said at his funeral that he would rather the firm die than have its principles compromised and, of course, it finally did both. Anything can happen. Look at life insurance companies. They were all mutual companies 25 years ago but have since become public stock companies, largely as a way to enrich their executives. If I may quote the Good Book, they "sold their birthright for a mess of pottage."

Portfolio: You've criticized companies for smoothing and managing quarterly earnings and analysts for preferring that practice to reality. What would it take to change things?
Bogle: The focus on engineered quarterly earnings statements reflects a switch in the orientation of institutional investors—away from long-term investing and toward short-term speculation. This has caused other problems in addition to managing earnings.

It used to be that mutual fund turnover averaged 15 percent a year. That worked out to a seven-year holding period. Turnover is now greater than 100 percent and the holding period has been reduced to 11 months. Mutual funds have become a rent-a-stock industry, and, partly as a result, have abandoned any notion of corporate citizenship. Eleven months is simply too short to care about corporate governance. So the mutual fund industry must accept a share of the blame for recent governance lapses and scandals in corporate America.

What we really need is a complete sea-change in the way institutions invest in this country—a return to long-term investing. We also need the mutual fund industry to return to its activist roots and take up the cause of shareholder rights once again.

I'd help things along with a tax on short-term transactions, assessed on taxable and tax-free investors alike. Today's long-term investors are largely index funds, and for the past three years I've been encouraging them to take up governance matters.

Portfolio: Do you have a view on REITs as an investment proposition?
Bogle: People should invest in total market stock and bond funds for the long term. Total market indexing is the gold standard. Anything else, like sector investing, is a dilution of that standard. When you pick sectors, you might be right or you might be wrong. Emotions take over. People tend to get into a sector after the good returns have already happened. It's the rowboat syndrome—investors look backwards, buying after the sector has done well and selling after the sector has done poorly.

Sector timing is difficult to the point of impossibility for an investor to do successfully. There's no known way to select a sector that will outperform on a long-term sustained basis. While REITs did 1 percent better per year than the S&P 500 during the 10 years from 1994 to 2003, in the 10-year period from 1988 to 1997 they performed worse and had higher (annual) volatility.

Portfolio: Total market stock and bond funds are the bulk of your personal portfolio.
Bogle: Yes.

Portfolio: You're still a total market investor despite the incredible run-up in the tech sector prior to March 2000 and the fact that REITs and other sectors have outperformed the market since then. Sector investing still doesn't impress you, even though the total market has been mostly down in the last few years. Come to think of it, not even losing your first job in the market decline of the 1970s shook your faith in total market investing.
Bogle: That's right. But I control risk by way of my bond market exposure—about 70 percent of my assets during recent years. As a result, I've done well, not only over the long-term, but also during the tough years since 1999.

My argument about sector funds isn't about REITs, per se. I could see an investor owning the Vanguard REIT fund, but I don't think they should make it more than 10 percent of his or her portfolio. No one should get overexposed to any one sector, and I'd be especially cautious when that sector is hot. My advice about indexing runs counter to those who are trying to build an investment advisory business. When their clients realize that total market indexing is best in the long run, it won't be long before they start asking, "What do I need you for?"

Portfolio: Speaking of people waking up, why do you suppose it is that people still buy most mutual funds when, as you have said, they cost too much and underperform?
Bogle: It's "the triumph of hope over experience," to quote Dr. Samuel Johnson. "Hope springs eternal in the human breast," as Alexander Pope said. No amount of evidence, it seems, can destroy that deeply ingrained part of the human psyche.

Portfolio: What are the biggest changes you've seen in 50 years of investing? Is anything being lost that is worth preserving?
Bogle: The most important single thing that's been lost is the notion of long-term investing. Three billion shares change hands every day. It didn't used to be like that.

Portfolio: Have any positive developments during your career made things better for investors?
Bogle: That's such a great question. Under pressure, mutual fund sales charges have in fact come down–from 7 percent or 8 percent in the 1950s and 1960s to 3 percent to 5 percent today. However, that reduction gets obfuscated by the games funds play with A, B, and C share classes—what I call "alphabet soup" shares.

Also, there's infinitely more information about the mutual fund industry available now. There are many articles in the press. And Morningstar is a wonderful service. It arms investors with all the information they need. With all the data available, however, it's too bad that people focus largely on recent performance. When they use the wrong information, they make the wrong decisions. "With all thy getting, get wisdom," as the saying goes.

The market is more liquid now and there are an infinite variety of mutual funds out there, but to what avail? What we need is a healthy dose of long-term investing.

Portfolio: As you look ahead, are you hopeful or pessimistic and why?
Bogle: I'm an eternal optimist. I always have been. I'm an idealist. Mankind will move in the direction of what's better, not worse. Right after September 11, the front page of The Times of London carried a photo of the remaining shards of the Twin Towers with the headline "Good Will Triumph Over Evil" written underneath. I had it framed and put it right outside my office.

Information is getting out about the high cost of mutual funds and the folly of dreamed-up sector funds. There's not a scintilla of evidence that active managers do better than indexing which is now one-sixth of all equity fund assets. That's truly remarkable growth. Things are moving in the right direction. Investors may ignore their own economic self-interest for my lifetime, or even yours, but they won't ignore their own economic interests forever.

I'm also optimistic we'll get an improvement in fund governance. We're making progress on putting the interests of shareholders first. In 10 or 20 years, this industry will be a much better place for investors to entrust their hard-earned savings.

Portfolio: What was it like for you personally to be a low-cost distributor? Did you take abuse or personal slights from others in the industry?
Bogle: I know a lot of people don't like my message but I'm too busy to notice what they say about me. But I'll tell you one story. A few years ago, I was in the audience at a meeting of the Investment Company Institute (ICI) when the speaker, an industry leader, named Vanguard and Bogle as the forces that were most hurting the industry. He said, "the problem with Bogle is not that he's a communist, he's a Bolshevik." I went up to him afterwards, smiled, shook his hand, and said, "I really appreciate the compliment. Around the office, they call me a fascist."

It's only a slight exaggeration when I say that at recent ICI meetings, most people who've been in the business 25 years or more don't even make eye contact with me. But the younger people, with unbelievable frequency, tell me that I'm their hero, and that they wish their firm could be more like Vanguard.

Portfolio: You have some things in common with Bill McGowan, the man who founded MCI and started the low-cost revolution in the long-distance business. He was a low-cost distributor, a visionary, and, like you, he had a heart transplant.
Bogle: I met him once in Washington after his transplant. This was long before I started thinking about one for myself. Contrary to what you might have heard, not all revolutionaries need heart transplants. Not much changed for me after my operation in 1996. I want to build a better financial America. Making our nation's values felt abroad depends on a strong capitalistic system that builds strong economic power. I want to leave things better than I found them.

But we're all sinners and I'm still the same flawed human being I always have been—the same old Bogle. But my career has been an unalloyed joy. I don't worry about the future. Nothing keeps me awake at night. There's no way other mutual fund firms can compete with Vanguard on price, and therefore on long-term performance.

Portfolio: You're 75 now, an age when most people are retired. But you're on the road, giving as many as four speeches in a day, speaking out on important issues like corporate governance and mutual fund reforms. What keeps you working? What gets you out of bed in the morning?
Bogle: The joy of living another day. Seeing the sun rise and set. The joy of contributing to society. The joy of my family. What means more to me than all the accolades, all the awards, and all the honorary degrees bestowed upon me, are the letters I get from individual shareholders expressing their appreciation. They followed my advice. They got their fair share of the markets' returns. They are absolutely convinced that their lives are better for what we've done for them. I get letters like that about every day. If that thrill doesn't get you out of bed in the morning, then you're a sad piece of work.