Listed offers active management opportunities not typically exploitable in equities or direct investing, write Jan Willem Vis and Raul Leote de Carvalho
Investors who have been inclined to dismiss listed real estate as an attractive asset class since the financial crisis should perhaps reconsider their position. They could be missing out on the important roles that listed real estate can play in multi-asset portfolios. Not only can it operate as a proxy for direct real estate while generating diversified returns – with a stronger income component arising from high dividends – it can also provide some protection against rising interest rates, which might come as a surprise to some.
These are some of the main conclusions drawn by new research from BNP Paribas Investment Partners – ‘The case for listed real estate in a multi-asset portfolio’.
The research shows that, over the long term, investment in listed real estate offers an exposure to direct real estate, while addressing the well-known illiquidity problems associated with owning individual buildings
Robust optimisation techniques show that listed real estate should be considered within a multi-asset portfolio for diversification against uncertainty in return forecasts and variance-covariance forecasts. In the long term, listed real estate tends to show low correlations with other asset classes and can thus offer diversification benefits. The underlying real estate exposure provided by real estate investment trusts (REITs), which distribute dividends to shareholders, and real estate operating companies (REOCs), which reinvest dividends in their businesses, also offers diversification through the ownership of portfolios of multiple properties.
From a broader investment management perspective, portfolio managers are able to realise the potential benefits from adding listed real estate to a multi-asset portfolio to generate additional uncorrelated alpha from exploiting both top-down and bottom-up inefficiencies in the asset class. Listed real estate offers opportunities for active management not typically exploited in either equities or direct real estate.
The research also considers the question raised by many asset allocators of whether it is worth investing in real estate when long-term interest rates, at least in the important US market, look set to rise. The historical performance of the asset class reveals that, over the past 20 years, investors would have been unwise to ignore its ability to benefit from inflationary shocks in addition to its diversification and performance-enhancing advantages. Real estate can still produce attractive income as well as the prospects of growth in a changing rate environment.
Active management will become more important as markets adjust to rising bond yields, as central banks such as the US Federal Reserve continue to reduce monetary stimulus. Investors need to be able to manage the sector differences that can be similarly exploited. Despite recent strong performance, active managers are in a position to focus on specific real estate sectors, emphasise individual city or regional markets and exploit themes across regions and countries.
Real estate contributes to portfolio diversification in a number of ways. In the short term, its relatively high correlation with risky asset classes such as equities limits the diversification benefit from an ex-ante risk point of view.
But robust optimisation techniques show that listed real estate should still be added to a multi-asset portfolio for diversification against uncertainty in return forecasts and variance-covariance forecasts. In the long term, listed real estate tends to show low correlations with other asset classes and thus the benefit in terms of diversification is more naturally observed.
We should not overlook the underlying real estate exposure that REITs and REOCs provide in terms of diversification through the ownership of portfolios of multiple properties, rather than investments in single properties.
Jan Willem Vis (left) is CIO of global listed real estate, and Raul Leote de Carvalho is deputy-head of financial engineering at BNP Paribas Investment Partners