INREV has taken another major step towards the creation of a styles classification tool, as Andrea Carpenter reports

Understanding fund style is of fundamental importance to the development of the European non-listed real estate funds market. Styles help form the basis for investors and fund managers to distinguish between different investment strategies and also allow for classifications for style sub-indices for creating benchmarks.

INREV has just released the next stage to its fund style framework, a process which will help the industry towards the development of a practical style classification tool for investors and fund managers to determine whether funds are core, value added or opportunity.

Defining styles would appear at first to be a simple task  investors and fund managers already work with their own internal styles classifications and INREV has a framework which it released in 2004. However, once we began to address the topic of revisiting the INREV framework with members, it became clear that it was a task that required INREV not only to consider the huge number of quantitative and qualitative factors that define style but also to translate that into a simple classification solution.

When INREV developed its first style framework in 2004, the two measures of target leverage and target internal rates of return provided a first guide for the industry to classify non-listed property funds as core, value added or opportunity.

At that time the model was not considered ideal but, taking into account the level of development of the non-listed real estate funds industry and the information available, this was considered the best that could be achieved. It was also recognised that the model would need to be refined in the future and this has been prompted now by shifting market conditions as the expected returns on real estate have fallen and debt markets, along with the contribution of leverage to return, have changed.

To guide the revisions to the framework, an INREV Styles Working Group was created and feedback from members was gained through a workshop. Cass Business School was also commissioned to bring together views from members and industry participants, as well as to consider existing research on the topic. The results of this work formed the thinking for the white paper that was published in the summer to gain feedback from members on the topic.

In this release of the final INREV Fund Styles Framework, the principles set out in the white paper have remained in place. The framework defines style as a "bundle of risks" and sets out a number of risk factors that are most important when determining whether a fund is core, value added or opportunity.

The approach acknowledges that while classifying styles involves both quantitative and qualitative factors, a robust solution requires any framework to concentrate on measurable, quantitative factors. Feedback from members focused mainly on identifying the correct quantifiable risk factors to ensure that those analysed contributed to determining style.

Consultation also confirmed the view that this could not be an immediate solution and that a period of analysis would be needed to validate the risk factors. In some cases, data on these factors have not been collected as part of the INREV Vehicles Database, so this could also prolong the process of creating the final classification tool. However, it was felt that taking the time to build a solid foundation with this analytical approach would result in a more enduring solution. 

The risk factors and INREV's approach is set out in the INREV Fund Styles Sheet. The sheet has been developed to provide guidance for fund managers and investors to understand the factors that will be analysed as INREV works towards the first set of style classifications based on analysis of existing vehicles in the market.

The order on the fund style sheet also reflects the thinking behind the principles of the styles framework. In part A, the risk factors that should be considered as input for the fund manager's own fund style classification (part B) are set out. Part C serves as a check for those using the fund style sheet as guidance that fund return is a result of the risk factors rather than an input.

At this stage in the development of a classification tool for newly launched funds, the sheet can be used in two ways:

For INREV it will be the basis for a questionnaire to collect data on existing funds from fund managers to support analysis of these risk factors in practice and the development of a styles classification tool. As a guide for fund managers to understand the concept of the styles framework and the risk factors that have been put forward as determining style.

As the framework does not prescribe the "boundaries" of these factors in determining the style of a vehicle, this style sheet cannot be used as a practical tool to define style.

However, INREV's next step is to develop this Fund Style Sheet into a practical analytical tool for style classification. First, INREV will analyse the relationships between these risk factors and the style categories of existing funds in order to develop a practical style classifications tool for fund managers.

To do this a pilot group of fund managers will submit data on existing funds and their declared style classifications to enable INREV to analyse the relationship between the risk factors and current style classifications. This should help identify clusters of funds with similar characteristics that share the same style and identify funds with characteristics at odds with those typical of funds in the same style category.

The results of this analysis will feed into understanding how relevant the identified risk factors are and whether any weighting of these factors is required within the framework to reflect their importance in the determination of style. This research may also prompt changes to the styles framework.

INREV will then undertake a full review of the consistency between the declared fund styles and the style factors, related to launch years, from the INREV Vehicles Database. This will help establish the typical characteristics of each style category and identify those funds that are inconsistent with their declared classification. This analysis will be undertaken periodically and the accumulation of data on style factors will allow the development of increasingly robust scoring and weighting systems for style classification of funds, resulting in a style classification tool.

While this next step does not immediately bring a new solution to classifying fund styles, we think the process is an innovative and forward thinking methodology that will ultimately bring about a robust, enduring and workable solution.

Andrea Carpenter is director of research and market information at INREV