UAE – Low returns in core real estate are tempting investors to move up the risk curve, but they should beware of unwittingly increasing their exposure to "private equity", according to Abu Dhabi Investment Authority's (ADIA) head of real estate strategy.
Paul Kennedy, who oversees the real estate exposure of the world's second largest sovereign wealth fund, told a conference in Cambridge, England, that leveraged and development-led property strategies should be funded by private equity allocations, or they risk "damaging" multi-asset portfolios.
He said the ADIA was a "substantial player" in opportunistic and debt strategies, but "these commitments are funded from specific credit and private equity allocations that have distinct benchmarks and guidelines" and are separate from the "stabilised" allocation.
Speaking at the IPD/SPR Real World Conference, Kennedy said "decisions to move up the risk curve to enhance returns should be viewed as an asset allocation decision from real estate to private equity rather than within a portfolio of real estate.
He added that, "in the run-up to the last property market crash, there were countless examples" of investors funding highly leveraged strategies from their property allocations "with disastrous implications for the overall portfolios".
"The unexciting nature of returns available from core assets in today's market may suggest similar conditions for a [move up the] risk curve – similar conditions for real estate professionals to twist their allocations," he said.
The ADIA separated the capital funding for its higher-return real estate strategies from its core, or 'stabilised', real estate allocation following research in 2009 carried by IPD on the ADIA's behalf, which showed that roughly 65% of the IPD universe could be described as core, 25% as core and value-added, and the remainder as development and opportunistic, with these weightings remaining fairly consistent over a number of years.
"We have deliberately taken [higher-return strategies] out of the stabilised real estate allocation to be funded substantially elsewhere," Kennedy said.
"The reason we've done that is the damage done to our portfolio and other portfolios in the past where investors have taken an allocation inspired by IPD-type assets and used it to fund private equity exposure, and they've 'outperformed' simply from leveraging beta or taking development risk."
Using the same philosophy, Kennedy questioned conclusions made by Robin Martin, research director at Legal & General Property, in a presentation on investing in alternative sectors in the UK, including residential.