EUROPE – The riskier a real estate fund's style, the more likely leverage is to account for its underperformance, according to an Urban Land Institute (ULI) study published this week.

Using a model that measured the impact of leverage on underperformance of 169 core, value-added and opportunistic funds, Reading University professor Andrew Baum and his team found opportunistic funds performed worst of the three styles on a risk-adjusted basis from 2001 to 2011.

A 60% leveraged opportunistic fund could expect to underperform annually by as much as 13.2%.

The research, which supports similar findings for the UK market, found that leverage was more significant than property selection in poor performance – effectively, that fund managers' selections had less impact on performance than previously thought.

When leverage was factored in, it turned out fund managers' decisions on property risk exposure were statistically insignificant.

Even where fund managers added asset-level value, each 10% of leverage in value-added funds reduced annual returns in value-added funds by 2%.

"The impact of leverage – especially in the 2008-09 period – was so punitive that the return delivered by any good work being done by managers was likely to have been obliterated," the report concluded.

However, its authors also stopped short of blaming fund managers for excessive use of leverage, pointing out that investors likewise "appeared willing to invest large amounts of capital in the strategies".

Despite evidence of a positive impact of leverage in rising markets, Baum questioned whether investors' view of the level of risk required for absolute returns in the period after the crisis had been realistic.

Although the report did not weigh external factors, ULI acknowledged the style-specific contribution of fund vintage, management and market factors in accounting for fund underperformance.

In core funds, for example – where leverage was only "partly" culpable – underperformance in the three years to 2011 could be the result of pressure on open-ended funds to deploy accumulated capital in overpriced prime.