GLOBAL - Leverage has been "destroying value" in real estate funds on a risk-adjusted basis, according to new research by the UK's Investment Property Forum (IPF).
Speaking at this week's Investment Property Databank (IPD)/Society of Property Researchers (SPR) Real World conference in Cambridge, former IPD head of research Malcolm Frodsham said leverage had a detrimental effect on the performance of balanced UK property funds.
The IPF-commissioned research surveyed 68 funds - 22 balanced funds (mainly property unit trusts), nine managed funds and 37 specialist funds. It found that managed funds returned 6.2% before leverage, but this fell by 19 basis points once debt was taken into account. Meanwhile, the risk - or volatility - increased by 10%.
Specialist funds saw their returns increase from 7.7% to 8.6% when accounting for leverage, while their volatility increased by 52%.
Addressing the specialist fund returns, Frodsham said that while a 90 basis points outperformance on 33% leverage might sound good, on a risk-adjusted basis it was "destroying value".
"Is this saying that leverage is good? Almost certainly not," Frodsham said. "If you look through these numbers, what you find is that there is absolutely no evidence whatsoever that systematically these funds were able to manage their leverage."
"They weren't able to have higher leverage when returns were strong and then reduce their leverage when returns were weak," Frodsham said. He added that while some were able to manage their leverage more effectively, these were the exception and not the rule.
Frodsham said the only reason specialist funds were able to add returns at all when leverage was taken into consideration was their strong overall performance.
Averaging out the findings across all three fund categories, Frodsham told attendees: "Leverage, overall, frankly added absolutely nothing - 0.03% - but it did inject an awful lot of volatility and I'm sure it also injected an awful lot of angst into the industry as well."
The study, 'A Decade of Fund Returns', also took aim at the lack of fee transparency within the real estate fund industry. IPF estimated that of the £11.1bn (€13.8bn) surplus posted by the surveyed funds over the decade, £2.1bn went on fees - reducing returns by almost one percentage point.
As a result, and after fees and costs, the funds delivered a net return of 5.8%, IPF estimated, outperforming equity and bond world indices in the same period.