This essay examines the ability of investors to take desired positions in the risk-reward space by building a portfolio of non-listed funds of different investment styles. The question is examined from the viewpoint of a major institutional investor not subject to meaningful capital constraints. While it is acknowledged that there might be significant practical barriers when implementing the desired portfolio strategy, the essay focuses on the basic theoretical viability. The latest research on non-listed property fund performance was drawn upon. Furthermore, data from the Association of Real Estate Funds (AREV), the European Association for Investors in Non-Listed Real Estate Vehicles (INREV) and the Investment Property Databank (IPD) was used for illustrative purposes. To begin with, a brief introduction to non-listed funds and the concept of risk and reward is given. Subsequently, the methodologies applied by AREF and INREV to classify non-listed property funds are illustrated. Thereafter, the historic performance achieved by different styles is discussed. Then, factors determining the INREV style classifications are compared with the performance drivers identified by recent research. The findings are summarized in the last section.
Table of Contents
1. Introduction
2. Non-listed real estate funds and the risk-reward space
3. Classification of non-listed real estate funds: AREF and INREV
4. Non-listed real estate fund performance and INREV style classification
5. Drivers of property fund risk and returns
6. Conclusion
Objectives and Research Themes
This essay evaluates the theoretical viability of constructing portfolios of non-listed real estate funds to achieve specific positions within the risk-reward spectrum, from the perspective of a major institutional investor. It critically examines whether existing fund classification frameworks, such as those provided by INREV and AREF, effectively capture the primary drivers of fund risk and return.
- Theoretical validity of portfolio construction in the risk-reward space.
- Evaluation of AREF and INREV fund classification methodologies.
- Impact of leverage, development exposure, and portfolio diversification on performance.
- Comparison between style-based classifications and empirical performance drivers.
- Limitations of current style frameworks in asset allocation decisions.
Extract from the Book
Non-listed real estate funds and the risk-reward space
A non-listed real estate fund is a vehicle, run by a fund manager, which pools the capital of three or more investors in order to undertake real estate investments (INREV, 2012a, p. 6). Funds with a predetermined life, usually 6-10 years, are called closed-ended funds. Open-ended funds do not have a fixed termination date and are designed to allow more flexible investments and redemptions (Baum & Hartzell, 2012, pp. 295 ff.).
Investors in non-listed property funds will consider the risk and return characteristics of the funds when allocating their capital. Basic financial theory states that expected returns should be greater for more risky assets. This can be described as E(r) = r_f + E(RP) where r_f is the return on a riskless security and E(RP) the expected ex ante risk premium. The risk premium depends on the risk perceived by the investor (Geltner, et al., 2007, pp. 186 ff.). Open-ended funds dominate the lower end of the risk-reward spectrum whereas closed-ended funds tend to aim at the higher end (Baum & Hartzell, 2012, pp. 195 f.).
Investors usually hold a portfolio of assets. Hence, the strength of association of asset returns, i.e. their correlation, becomes an important component in determining the portfolio risk and return position (Brown & Matysiak, 2000, pp. 249 ff.). Modern portfolio theory offers a framework to compute and optimize expected portfolio risk and return. While its applicability in a property context is seriously questioned (Sirmans & Worzala, 2003, p. 1090), it is important to acknowledge that the total risk of a portfolio is usually different from the weighted standard deviation of its assets. To assist investors with investment decisions and portfolio allocation it can be useful to classify funds in distinct categories (Lee, 2008, p. 3). The following section will describe the methodology used by AREF and INREV to classify non-listed real estate funds.
Summary of Chapters
Introduction: Outlines the essay's focus on the theoretical viability of portfolio construction using non-listed funds and introduces the primary data sources (AREF, INREV, IPD).
Non-listed real estate funds and the risk-reward space: Defines non-listed real estate vehicles and discusses the theoretical relationship between risk and return in portfolio management.
Classification of non-listed real estate funds: AREF and INREV: Details the methodologies used by AREF and INREV to categorize funds based on their investment focus, leverage, and risk profiles.
Non-listed real estate fund performance and INREV style classification: Analyzes historical performance data of different fund styles and compares them against the current classification frameworks.
Drivers of property fund risk and returns: Examines factors such as leverage, development exposure, and portfolio size, and questions whether these are sufficiently reflected in current style classifications.
Conclusion: Synthesizes the findings, arguing that investors must look beyond current style classifications for effective asset allocation due to observed inconsistencies and ignored risk factors.
Keywords
Non-listed real estate funds, Risk-reward space, INREV, AREF, Investment style, Portfolio management, Leverage, Property fund performance, Asset allocation, Tracking error, Core funds, Value-added funds, Opportunity funds, Development exposure, Market returns.
Frequently Asked Questions
What is the primary objective of this coursework?
The essay aims to determine whether investors can effectively build portfolios of non-listed real estate funds to reach specific positions in the risk-reward space, considering the limitations of current style-based classification frameworks.
Which organizations provide the classification frameworks discussed?
The paper primarily analyzes the classification systems provided by the Association of Real Estate Funds (AREF) and the European Association for Investors in Non-Listed Real Estate Vehicles (INREV).
What is the core argument regarding current style classifications?
The author argues that current style classifications (like those from INREV) fail to capture major drivers of fund risk and return, such as specific country and sector allocations or portfolio size, rendering them insufficient for precise asset allocation.
What scientific methods are applied in this research?
The work utilizes a comparative analysis of academic literature, statistical reports from industry bodies (IPD, INREV), and empirical performance data to evaluate the relationship between fund styles and realized risk-return metrics.
What are the main risk drivers for property funds identified in the study?
Key drivers include leverage (LTV), development exposure, country and sector allocation, and portfolio diversification, which are found to have a significant impact on fund volatility and returns.
How is the performance of different fund styles typically characterized?
Performance is generally characterized by a spectrum where "Core" funds target lower risk and stable income, while "Value-added" and "Opportunity" funds aim for higher returns through development and greater use of leverage.
Why are "Core" funds' leverage ratios considered a point of inconsistency?
The study notes that some "Core" funds report leverage ratios exceeding those permitted for "Value-added" funds, highlighting a lack of standardization or consistency in how these categories are managed in practice.
What challenge does the dispersion of returns pose for investors?
The wide dispersion of returns, particularly within "Opportunity" funds, suggests that relying on style labels alone creates significant uncertainty regarding a portfolio's true position within the risk-reward space.
- Quote paper
- Tim Schabsky (Author), 2013, Real Estate Fund Management: Non-Listed Funds and the Risk-Reward Space, Munich, GRIN Verlag, https://www.grin.com/document/231341
