Investment managers hampered by benchmark misalignment, says MSCI-IPD

The battle on the part of real estate investors to unify long-term goals with the short-term nature of asset management is as prevalent as ever, according to a report published this week by New York-based provider of investment decision support tools, MSCI Inc.

The report, titled ‘Long Run Investment Ambitions and Short Run Investment Processes’, is a bi-annual survey of asset allocation practices among pension funds and sovereign wealth funds globally.

‘The survey results show that the biggest challenge these asset owners face is unifying long-term goals with the short-term nature of asset management,’ said Neil Gilfedder, managing director and head of analytic applied research at MSCI in Berkeley. ‘There is no consensus in either the frequency with which they make strategic asset allocation decisions or in the methods they use to do it. This can lead to wide variation in investment outcomes.’

Investment outcomes can also be seriously affected by one of the biggest problems facing investment managers today: benchmark misalignment.

‘Benchmark misalignment is a problem, often caused when investors change their investment strategy, either in terms of geographical location or asset classes,’ said Peter Hobbs, managing director of research at MSCI-IPD in London.

Reluctance to change
‘There’s a certain inertia to changing benchmarks, so often an investment strategy may change but the benchmark hasn’t caught up. For example, if you have a US investor using a US benchmark to invest in opportunistic assets in Europe, that’s not going to align – this is a widespread problem,’ Hobbs added.

According to the survey, although 70% of asset owners have real estate policy benchmarks, over 80% of them have some benchmark misalignment, typically as a result of using domestic benchmarks in foreign markets.

However, as real estate becomes more global, benchmarks will be revised to reflect new investment strategies, Hobbs added. Newer real estate investors, such as Middle Eastern and Asian investors, have been able to start with a clean slate by creating global benchmarks. This is often done because their management boards want different asset classes to have their own benchmarks. In addition, some of these asset owners have built sophisticated teams and processes. ‘For example, when some asset owners acquire major buildings occupied by a financial services tenant, some of them dispose of their equities portfolio holdings in that company to manage their overall exposure to the specific company. An increasing number of asset owners are integrating real estate within their overall risk management practices,’ said Hobbs.

Benchmarks are more widely used today by investment managers than before the financial crisis, although many are domestic-based, rather than global, focusing on the strategy of the relevant fund or separate account. More sophisticated managers and asset owners are starting to use mandate-specific benchmarks to help build transparency and strengthen the relationship between the two parties, said Hobbs.

Benchmarking misalignment is also emerging ‘due to the increasing global capital flows away from domestic markets’, according to Ian Chappell, head of fund management at AXA Real Estate in London. But there are ways of mitigating it, according to Chappell: ‘When we’re talking to investors from different markets, we generally give them an absolute measure, such as an IRR, as a way to give them a degree of comparison across different markets. However it’s also hard to benchmark investors’ perceptions of investment risk strategies, which can mean different things to different investors. What some would categorise as ‘value-add’ might fall more into the ‘distressed’ camp for others,’ he said.

Lack of dialogue
Another major issue is the lack of dialogue between many risk teams and real estate teams. ‘The biggest problem, other than benchmark misalignment, is the dialogue between overall risk teams, which are very quantitative, and the real estate teams who can think about issues such as leases and rents but who can’t ‘connect’ with volatility. It’s about trying to convert the real estate issues into metrics that the risk teams can also understand. Managers need to trust risk teams and vice versa; it’s about trying to get that alignment organisationally…all the ingredients are there,’ said Hobbs.

Before the financial crisis, there was little central risk management of the real estate department as it was complicated and didn’t represent a large part of investors’ portfolios. Today, alternative asset classes - of which real estate is the biggest component - account for 20% to 25% of portfolios globally and there is far more scrutiny from central risk management teams. ‘Have lessons been learned? We’ll find out in the next two-to-three years!,’ said Hobbs.

The MSCI-IPD survey was carried out in the fourth quarter of 2013 with 80 global asset owners whose assets totalled almost $4 tln, according to MSCI. The responses were supplemented by asset allocation data gathered from both annual reports and other public documents of 138 global asset owners. (MSCI acquired UK-based IPD Group in October 2012 for $125 mln, marking its foray into the real estate investment benchmarking business.)