A new paper by Alexander D. Beath and Chris Flynn examines the significance of real estate investing within the portfolios of large European institutional investors from 2005 to 2016.
Beath is a senior research analyst with CEM Benchmarking, with a PHD. from McGill University on condensed matter and materials physics. He and Flynn bring to bear on the issue of real estate investing a vast database: CEM Benchmarking has been collecting portfolio data for 25 years from large institutional asset managers on their holdings, policy weights, returns, and benchmarks.
Their report begins with the observation that the CEM database is free of performance bias because “performance is not the motivation for working with CEM Benchmarking.” The motivation, rather, is cost-efficient benchmarking.
Types of Real Estate Investment
The portfolios of the institutions within the database include both listed and unlisted real estate assets. “Listed real estate” breaks down into four constituent categories. They are based on investment style and motivated by the different costs involved: internal active, internal passive, external active, and external passive
“Unlisted real estate” involves no passive investment real estate style, and the unlisted real estate data “has been aggregated into a single asset class” for purposes of this study.
The data is further divided regionally into Dutch funds, UK funds (for whom the data begins in 2008), and other Euro area funds. The “other” category includes funds from Denmark, Finland, the Republic of Ireland, Norway, Sweden, Switzerland and France.
Most, though not all, of the funds included in the study are traditional defined benefit pension funds. Of the funds included in 2016, the last year of the database, 92% meet that description. Another 4% are buffer funds for defined benefit pension systems, and 3% are asset managers for defined benefit pensions.
Over the full 12-year period under discussion (2005-16), the Dutch funds outperform other Euro area funds by nearly 2%.
For the period that includes UK funds as well, 2008 – 2016, Dutch funds outperform the UK funds as well as the other funds, through the UK funds made a closer race of it. When the period examined is narrowed to 2010-16, though, UK funds take the lead.
At least five reasons exist for different performance of the three regionally defined fund groupings: outperformance within asset classes; superior asset allocation; successful derivative/overlay strategies; lower cost implementation; and foreign exchange.
The issue of real estate’s contribution falls under the heading “superior asset allocation” in that list. Listed real estate allocations for Dutch funds average 1.9 percent, a figure notably larger than for other Euro area funds, 0.2 percent, and larger than that for the U.K. funds, 0.3 percent. The Dutch advantage is diminishing year to year. The report says that “listed real estate allocations are decreasing by -0.1 percent per year for Dutch funds in absolute terms, and by -7.9 percent per year in relative terms.”
The UK leads in unlisted RE allocation by a slight margin over the Dutch fund (6.4% to 6.1%, respectively) and they both lead by a large margin over the (rest of) the euro area (at 5.1%).
Real Estate is Good for Pensions
Yet Beath and Flynn warn against direct comparisons because of the significance of foreign exchange. A UK fund and a Dutch fund “could have the exact same investments and implementation in a foreign asset class but produce different returns in their home currencies because of differences in foreign exchange rates.”
The bottom line is that real estate, listed and unlisted, has been good for European funds, on both sides of the channel.
As a related matter, the study also discusses the costs of various investments, where “cost” takes in internal front-office trading costs, external base manager fees, external performance fees, private equity carried interest, and trading costs as well as internal oversight costs.
Real estate is typically much less expensive in Europe than is a private equity or hedge fund allocation.
The Concluding Caveat
The paper concludes with some cautious let-us-make-the-compliance-office happy language. “CEM Benchmarking is not an investment consultancy and does not provide advice on how clients should invest. CEM makes no warranty about the accuracy of the data provided and is not responsible or liable for any investment decisions made on the basis of the data provided herein.”