Limited exposure to listed real estate is resulting in lower returns for European investors, according to a new Oxford Economics study conducted in partership with EPRA.
Examining the risk-adjusted returns of model portfolios with differing levels of listed real estate exposure, the study found that no portfolio is optimally constructed without exposure to this typically underrepresented asset class.
The proportion of listed real estate in an optimally constructed portfolio varies depending on risk appetite and time horizon. It can range from 10% for a cautious investor, while an adventurous investor’s allocation to the asset class could be as high as 25%, on average. In Europe, investor exposure to real estate is typically no more than 3%-5% (with the majority of holdings being direct).
One of the reasons for low exposure to listed real estate in Europe is that the asset class has traditionally been considered a subgroup of general equities, because shares are publicly listed and traded, leading people to believe that its performance is closely correlated with general equities. As a result, investors tend to favour direct investment in real estate to diversify their portfolios.
However, this report finds that the correlation of listed real estate to equities is only 'moderate', albeit dynamic and dependent on levels of stress in financial markets. This is consistent with the findings of other empirical studies that the performance of listed real estate is comparable to direct real estate holdings over the mid- to long-term.
Dominique Moerenhout, CEO of EPRA, said: 'One of the greatest puzzles for all investors is maximising returns while mitigating risk, and this has never been more important. Europe is about to face a pensions crisis due to an ageing population, while markets such as the UK are seeing often unsustainably small contributions to pensions through defined benefit schemes as well as limited use of insurance and investment products. Something has to change.'
He added: 'There are significant pension funding gaps, and it is clear now that a sensible amount of exposure to listed real estate in any circumstance is beneficial to returns while diversifying portfolios and mitigating risk in the long-term. These findings provide further evidence for our outreach towards the European investment and pensions industries.'
