As double-digit returns become a distant memory, investors are seeking more information to rate the performance of funds. Christine Senior investigates investor concerns and how fund managers can address them

In the good times investors were somewhat blasé about the details of their real estate investment performance. If returns come in annually in double digits there is little need to dig deeper under the surface to find out what is behind the figures. But when times get tough, investors start to ask more questions: Just what is behind dismal performance figures? What factors have dragged the fund down? How much is due to the fund manager's asset selection, level of debt and the quality of risk management compared with the market as a whole?

"In the good times, when people were just concerned with headline figures, investors tended to focus on the investor-level return after all the costs, all the influence of debt, and were not necessarily too concerned on how that performance was delivered," says Andrew Smith, chief investment officer at Aberdeen Property Investors.

"They would look at the bottom line and focus on that. If fund managers were doing their job thoroughly they would be looking to make sure the underlying property portfolio was robust and performing well against similar assets in the market, assessing what they were adding in terms of asset management skills and stock selection and, equally, understanding what additional effect on performance would come through from the financial structuring and the cost base, in order to make that reconciliation between the underlying property return and the eventual investor-level return. I think investors have got much more focused on the detail of that as well now."

The level of detail end-investors receive may depend to a large degree on how close they are to the investment management process. A large sophisticated pension fund might manage its own real estate. Its real estate team, or the external manager delegated to manage it, may well subscribe to International Property Databank's (IPD) portfolio analysis service, which provides in-depth analysis down to performance of individual assets held. But a pension fund investing in real estate via a fund of funds is a couple of steps removed from the actual investment, and detailed breakdowns are harder to come by.

"As the investor gets further away from the assets, they probably get less visibility on the numbers," says Bill Hackney, chief operating officer at Cordea Savills. "If you invest in a fund of funds, the manager tells you what a good job he has done in picking one fund over another, how that contributed to the return achieved, but probably doesn't go as far as saying: ‘In my fund of funds, 10% was exposed to fund ABC. Five percent of fund ABC was exposed to a shopping centre. That shopping centre performed really well and that's why the fund of funds performed really well'. I think it depends on the pension fund and what questions it is asking about performance."

Fund managers should be unpicking the details of their funds' performance to find out which elements of their fund management boosted return and which were a drag on performance. As well as looking at the influence of manager skill through stock selection and management of the assets, and the effect of gearing on fund performance, they should be analysing the quality of the assets, the security of the rental income, credit rating of tenants and length of leases.

"Investors probably want headline information, but the fund managers themselves need to be burrowing into it in a lot of detail, really understanding it and putting action plans together," says Smith. "That is good practice in any environment. A recession concentrates people's minds on the need for it."

Aberdeen Property Investors uses IPD's service to rate security of income on its funds through analysis of lease length and quality of tenant.

Risk measurement is certainly a key area for analysis in the wake of the financial crisis. Historically, investors have been less concerned about the risks involved with real estate than they have with assets such as equities or bonds, because the asset class has been perceived as simpler in structure.

But this is changing. CIOs and boards of pensions funds are asking more questions, says Jack Foster, head of real estate at Franklin Templeton: "Does the manager understand the risk profile of the underlying tenants and, in this environment, the changing risk profile? Do many property managers have Bloomberg to assess the daily changing credit rating of their underlying tenants? And where you don't have credited tenants, how are you assessing their ability to pay rent?"

Other risks with a rising profile are to do with energy efficiency and climate change. "More investors are demanding to know the energy efficiency of buildings," says Foster. "Risks have evolved over time. Risk could be the quality and efficiency of the building from an energy point of view. That has become an increasing risk associated with the UN guidelines on environmental aspects."

The fund manager may use internal resources to provide detailed performance measurement and performance attribution analysis or use an external provider. IPD offers services for independent monitoring, but these don't come cheap.

"Generally it is something where costs are borne by the clients, because it provides the information and verification they want," says Smith. "We have had situations where investors are not keen to pay the price for an independent performance measure by IPD if they can have identically calculated performance numbers signed off by their auditor." The same figure is independently verified and calculated in the same way, but without incurring the same fees, Smith adds.

"We collate huge volumes of asset level data to a single transparent standard, and so provide perfectly matched benchmarks, full performance comparisons and detailed analytics," says Ian Cullen, co-founding director of IPD.

"Auditors can perform none of these services because they address just the financial bottom lines. IPD's services benefit from many specialist skills and significant economies of scale, and are charged on the basis of equally transparent fee scales which are linked to the success of the market and agreed with industry representatives in an open fashion."

Whoever is doing the analysis, the quality of the figures produced depends on the quality of the data fed into the process. It's a case of ‘garbage in, garbage out', as Hackney at Cordea Savills puts it.

"If you are a UK fund management group, you can collect data on portfolios send it to IPD and they produce portfolio-wide analysis, house-wide portfolio-by-portfolio analysis, benchmarking a particular portfolio against a chosen IPD benchmark. They have a range of standardised and customised benchmarks. There is lot of flexibility out there. But ultimately the quality of output is a function of the input. I know IPD spends a lot of time trying to ensure quality is there in the data."

One of investors' biggest concerns about performance figures centres on valuations, particularly valuation methods and how speedily they can be made.

"The biggest issue we hear from funds is getting valuations to come more quickly," says Foster. "The next thing investors want is confirmation of how valuations are being achieved, especially in an environment where transactions that support valuations have dried up. Pension funds have seen substantial reductions in value in their liquid portfolios of equities and bonds. We know real estate valuations tend to lag equity and bond markets substantially. Valuations happen more slowly in terms of rental rate declines and you don't get them for a period of time. Preparing a valuation takes up to three months."

Andrea Carpenter, director of research at the European Association for Investors in Non-listed Real Estate Vehicles (INREV), also believes that what is important to investors in the current environment is to know what lies beneath the performance figures managers present them with.

"That brings up some of the key issues in the market at the moment," says Carpenter. "For example, what is the impact of debt in a portfolio? And also about valuations in the market. In this market it is more difficult to value, so investors want a bit more information about the method of valuation. That is very important to feed into the net asset value (NAV) figures in the fund."

Speed of valuation also has a high priority for Theo Offringa, senior portfolio manager, real estate investments, at TKP Pensioen. "In the current market, it is of great importance for our clients (pension funds) that they receive performance data with a time-lag that is as small as possible," he says.

"For us, the issue with performance measurement is not particularly the technique or the tools. More important for us, as a manager of two funds of funds in Europe and Asia, is that we receive the performance data of the funds in which we invest as soon as possible after the end of a reporting period."

In December, TKP asked all 40 private real estate funds it invests in to report an estimate of their NAV at 31 December 2008 before 6 January 2009. Some 90% of the funds responded in time, enabling TKP to report NAVs to investors based on Q4 figures rather than Q3 figures two days later.

Pension funds are also exacting tighter standards of auditing in the wake of scandals in other markets such as equity. Although real estate, as a bricks and mortar asset, provides less scope for investors to be duped about their money disappearing into non-existent assets, the current climate makes them keener to ask more questions about the integrity of their portfolios.

"Investors have concerns about assets that are held and the need to confirm to their board that there really are assets," says Foster. "High profile scandals have impacted investors around the globe in the last six months. Investors are asking for clarity on audit procedures and accounting procedures."

Dutch pension fund Metalektro (PME) has a real estate portfolio worth €7bn, of which €1.5bn is invested in the domestic market. The fund's fiduciary manager, MN Services, has the responsibility for keeping a close watch on performance measurement data from Syntrus Achmea, manager of the Dutch property portfolio.

PME's investment manager, Marion Verheul, says valuations for real estate are trickier than for listed assets. "It's important to define how you want the valuation process to work. Valuers go out to buildings and it's difficult to make sure they all apply the same rules."

Verheul says it's important to know where the performance of the real estate comes from: "It is a core portfolio, so you can endlessly measure why your performance is different from the benchmark, but in real estate that's not all that relevant. But we do want to see where the performance came from. We keep real estate a long time in the portfolio. Sometimes it needs to be updated, so we expect constant analysis of what we are spending on the property, and is it still a good yield?"

Valtion Eläkerhasto (VER), the state pension fund of Finland, which invests in 16 funds, a mixture of single managers and funds of funds, has not asked for more detailed data in response to the financial crisis. But managers are being more active in providing information, according to VER analyst Johannes Edgren. "Some of the funds are more active in communicating with investors, and are providing more data by themselves without us having to ask," he says.

For Danish pension fund property manager ATP Real Estate, the key to getting accurate performance measurement data from the funds it invests in is to set up an appropriate framework from the outset. ATP invests in 26 funds, mostly targeting European property. Before investing, it carries out a detailed analysis to understand the business plan, the type of returns targeted and the risks taken.

"That forms the basis for ongoing monitoring and performance measurement of the fund so we make sure the manager sticks to the strategy," says investment manager Ville Raitio. "If the manager starts to deviate from that strategy it's hard for us to see if he is going outside his expertise and doing something not in his core competence. The other thing is that investments are very long-term in nature. We need to balance that with potentially seeing a big change in the market like we see today. So you need to have flexibility in reviewing the situation and making any changes necessary."

Some elements of the performance will be driven by factors outside the real estate market. Raitio believes that is why it is important to break down the performance figures.

"With a lot of funds applying fair value accounting, you can see big changes in the values," he says. "Not all are real estate-related. Some may be driven by derivative contracts the fund entered into, or driven by exchange rates. At the end of the day, it is a real estate investment, so you want to understand what is the impact of the real estate market and real estate strategy, and separate that from the capital structure of the fund and the hedging decision, and look at different components one at a time."