IPD launched a dedicated Spezialfonds index last year, offering greater transparency. Daniel Piazolo and Sebastian Gläsner explore the latest numbers

The German market for open-ended property funds under German investment law can be divided into three groups. The first consists of 22 public funds that are open to retail investors. With a total fund volume (NAV) of €73.6bn, this group contains the largest open-ended funds. The second group is real estate Spezialfonds, with more than 200 funds worth €36.4bn. The third group is formed by institutional public funds. Those funds are legally structured as public funds, but are exclusively available to institutional investors. The group contains 30 funds with €11.5bn NAV. Since both Spezialfonds and institutional public funds target institutional investors, they make up the relevant market for the IPD/BVI German Quarterly Spezialfonds Index SFIX.

Over the past decade, fund volumes of retail products and institutional funds have developed differently. Retail fund volumes were quite volatile at the beginning of the millennium, with figures starting at €45bn in 2000, reaching a peak of more than €80bn in 2004, and dropping back to €74bn in 2012. Fund volumes of institutional products, in contrast, showed a constant growth between 2000-12. The aggregated fund volume of open-ended property funds of institutional investors rose from €8.7bn in 2000 to €47.9bn in 2012, moving upwards in recent quarters.

Market transparency among German open-ended property funds for retail investors has grown improved constantly over the last few decades and has reached a high level international. Detailed information on the fund characteristics and fund performance is publicly available for all 22 vehicles, and IPD publishes a monthly performance index covering 100% of the market.

For open-ended institutional property funds, and especially for the Spezialfonds, market transparency has been very limited. The publication of the IPD/BVI German Quarterly Spezialfonds Index SFIX in the third quarter 2012 is a huge step towards greater market transparency. Participating funds disclose recent and historic performance information on a confidential basis to IPD so it can provide a meaningful and timely benchmark to the fund industry. The SFIX index starts in December 2006 and is updated on a quarterly basis six weeks after the end of the quarter. Since the index started, both the fund market and the index coverage strongly grew. By the end of the third quarter 2012, the index contained 110 funds with €27.5bn NAV and covered 60% of the German institutional property funds market.

Figure 3 shows the headline index development starting in December 2006 at 100. The lines refer to the quarterly index and regional sub-index returns, and the shaded area states the aggregated index performance of the headline index. The overall SFIX index contains 110 funds with €27.5bn NAV. Since the sub-index SFIX Europe has 53 vehicles with €15.9bn NAV compared with only 44 funds in the SFIX Germany with €9.3bn NAV, the performance of the SFIX Europe funds has a stronger impact on the headline index than the performance of the German allocated funds. In the years 2006 and 2007, both regional sub-indexes performed at a comparable level. From the year 2008 until today, the performance of the SFIX Germany is significantly higher than the performance of its European allocated counterpart. The weak performance of European direct property markets is also reflected in the SFIX Europe returns.

The table over page summarises the main index results available each quarter. The performance of the SFIX Germany exceeds the results of the SFIX Europe in all time periods reported. In the five-year period ending Q3 2012, the outperformance reached 2.6 percentage points on an annualised basis. However, outperformance of German allocated funds has to be put into perspective, since sector allocation of both regional sub-indexes differs substantially. While the majority of European fund portfolios are predominantly invested in office and retail properties, many German portfolios are invested in more specialised assets such as logistics, hotels or health. Therefore, a part of the outperformance of the SFIX Germany can be explained by the poor performance of funds invested in office properties.

The performance of the SFIX split by sector allocation shows that office performed worse in all analysed periods. As a consequence of the limited sample size of specialised funds with regard to sector allocation and the confidentiality of fund data, IPD cannot publish sub-indexes for those subsets, but the performance of 15 vehicles worth €2bn NAV with an investment focus in logistics, healthcare, residential and hotels tended to outperform the funds with a classic sector allocation. More details on the SFIX sub-indexes and their asset allocation are available in the annual study on institutional fund performance.

The outperformance of German allocated Spezialfonds began in 2008, and to the end of the third quarter 2012, the sub-index was at 131 points, an increase of 31% compared with the index inception in December 2006. The sub-index SFIX Europe reached 116 points, equaling a 16% return over the 13 quarters starting in Q1 2007.

The outperformance of SFIX Germany funds is in line with relatively stable direct property performance on the German market in recent years. While many European markets suffered substantial negative capital growth rates in 2008-09 – which offset positive income returns – negative capital growth in Germany was less severe.
Consequently, the property total return remained positive in all years, and so did fund returns. The weak performance of property funds predominately invested in office properties mentioned before is mirrored by the relatively weak performance of German direct office properties. While all German direct properties returned 3.8% on an annualised basis between 2007 and 2011, office investments yielded only 2.9%. The performance development of German allocated property funds for private investors (OFIX Germany index) is in line with the performance of funds for institutional investors (SFIX Germany), but institutional funds outperformed funds for retail investors in all periods analysed. While SFIX Germany funds generated 5% annualised return between 2007 and 2011, OFIX Germany funds returned 2.9%. Besides differences with regards to the sector allocation between both groups, institutional funds employ on average more debt.

The relatively weak performance of European allocated funds corresponds to the weak performance of European direct markets in recent years. However, European property returns differed strongly among markets in the period analysed, and the regional asset allocation of SFIX Europe funds varies as well. Figure 6 shows the spread of SFIX Europe fund returns. Individual fund returns often deviate strongly from the index. The width of the inner 50%-band of fund returns (grey column) varies between 3.2 percentage points in 2008 and 6.1 percentage points in 2010 and 2012. This means that the SFIX Europe annualised (Q1-Q3) index figure for 2012 is 0.6%, but the returns of the best-performing quarter of funds exceeded 4.3%, while the returns of the lower quartile were below -1.8%.

The diversification of assets among different markets to mitigate investment risk is the core idea of portfolio theory. The asset allocation of the SFIX Europe index is well diversified across European markets, and the annualised return volatility is very low at 1.1%.
Individual SFIX Europe funds also spread their assets across different markets, but their return volatility is usually much higher than the index volatility. The median annualised volatility of SFIX Europe funds with at least 36 months of performance data available is 3.1%, which is almost three times higher than the index volatility. The upper quartile of the volatility of individual fund returns is at 4.3%, and the lower quartile at 2.1%. This means that even the 25% of funds with the smoothest return development showed a return variation almost twice as high as the index. Only three out of 41 funds have an annualised volatility below the volatility of the index. Those figures imply that the majority of European allocated SFIX funds are not fully diversified. The average fund size of SFIX Europe funds is €301bn NAV, therefore complete diversification across Europe is not possible for most funds.

Since many institutional investors diversify their assets across different funds, a complete diversification is not intended in many cases. A very common portfolio of German Spezialfonds with a European asset allocation is strongly invested in France, the UK and the Netherlands, but not in Germany. Those investors usually have direct property portfolios in their home markets, and diversify their assets across Europe using indirect vehicles. With the publication of the IPD/BVI Spezialfonds Immobilien Index SFIX, investors are not only provided with a reliable and timely performance benchmark, but also with an analytical tool to estimate the potential level of diversification benefits available.

Daniel Piazolo is managing director and Sebastian Gläsner is funds services manager at Investment Property Databank