How consistent is outperformance? How relevant is NAV? These were themes at IPD/IPF's 2007 conference. Richard Lowe reports
The annual IPD/IPF Property Investment Conference returned to the shores of the UK at Brighton last November. But for the first time its programme was entirely devoted to indirect investments. While the two organisations could not have picked a more uncertain time to do this, their objective to address the "rise of the alpha manager" was at least timely given that lower return expectations for the asset class will no doubt bring an increased demand from investors to capture alpha and capitalise on troubled markets.
Robert Page, founding partner of Alpha Beta Fund Management, urged investors to expect a rapid growth in both beta and alpha products, with the former providing immediate access to markets and hedging capabilities, and the latter offering uncorrelated sources of returns.
Beta products - primarily in derivative form - "provide the link between different markets, sectors and instruments", Page said, enabling hedge fund techniques that can "exploit market inefficiencies" and increase the potential for returns that are "more stable and uncorrelated with the property cycle".
Until recently it has not been possible to access pure beta in property and it is inaccessible in many markets, but Page was confident the "industry's demands to globalise" will drive the growth and developments of beta products. And this in turn will enable the separation of alpha and beta strategies and provide a "virtuous cycle" as both "feed off each other".
However, Paul Mitchell, director of Paul Mitchell Real Estate Consultancy, revealed the difficulties in measuring the success of alpha managers. If alpha is defined as the outperformance arising from the skill of the fund manager, Mitchell argued the "acid test" is the extent to which such outperformance can be "sustained over successive periods".
Using IPD data, Mitchell went on to show that the top quartile of funds in 1987 displayed outstanding relative performance in that year, but that thereafter (until 2005) they showed on average unexceptional performances.
"It suggests that, at least for some, outperformance may be due to a one-off good or lucky deal or sector bet," he said.
Again using IPD figures, Mitchell showed the proportion of top performing funds over a five-year period that were then able to sustain their performance levels over a further five years and compared this to expectations based on ‘random luck'. The proportion of those funds remaining in the top 50% matched expectations, while the number of funds remaining in the top quartile was "on the margins of statistical significance".
However, almost twice as many funds as would be expected succeeded in remaining in the top decile, suggesting that to really gain alpha investors need to target fund managers in the top 10%.
However, Mitchell made the point that such outperformance may be associated with greater risk in the funds, such as that achieved through gearing or by an opportunistic fund. In such a case outperformance would be seen by investors as a reward for risk and not a return due to skill - in other words, beta not alpha. For this reason, to isolate alpha, the return due to risk "must be stripped out". Unfortunately, this significantly reduces the proportion of top funds remaining in the top rankings.
Mitchell concluded: "While there are funds which outperform, the proportion which repeatedly do this is not much higher than would be expected by chance. Furthermore, some of this outperformance is attributable to stronger risk, rather than skill or alpha. Evidence that UK property fund managers can systematically deliver alpha is therefore tentative and at best limited to a small group of funds."
Also of interest were comments made by Alec Emmott, principal at Europroperty Consulting, who suggested that European REITs are effectively being formulated to appeal to the "wrong audience". The traditional REIT model is aimed at producing beta, he said, but the European capital markets, "through the professional and traditional sector managers and analysts, are telling us to produce alpha".
Meanwhile, IPD's co-founding director, Ian Cullen, revealed the challenges in maintaining a traditional bottom-up measurement methodology, brought about by the increasing prevalence of gearing among indirect offerings of property returns. Fortunately, he said, patterns are beginning to emerge from the lengthening histories of funds, allowing IPD to assess the impacts that leverage and fee structures can have on underlying property returns.
And Julian Schiller, a director of corporate finance at Jones Lang LaSalle, addressed the problem of valuing indirect investments, suggesting that net asset value (NAV) does not necessarily represent investment value or "worth". According to Schiller, NAV only represents value at a "snapshot in time"; in order to calculate its worth, traditional investment considerations must be applied in addition to a rigorous assessment of the fund's current NAV.
He argued that investors could benefit from a lack of transparency and more subjective investors pricing considerations in the unlisted market. "A mismatch between NAV and investment worth means that the unlisted market is often mispriced and therefore represents an opportunity for investors," he said.
IPD also held its inaugural central and eastern Europe (CEE) conference in December. Held in Budapest, the event was used to launch IPD's first index of CEE property returns, posting a total return of 17.5% for the region in 2006.
IPD associate director Nassos Manginas revealed how this had been achieved with the help of a number of global fund managers, although they have yet to obtain local investor participation - something they intend to work on.
Simon Rubinsohn, chief economist at RICS, offered an optimistic outlook for the region, likening CEE to "an oasis of stability" in comparison to the mature Western markets already affected by the global credit crisis, and the Baltics and South East Europe, which look more "vulnerable".
More specifically, Rubinsohn said the CEE economies are better balanced than those of the Baltic region and South East Europe, citing low inflation, comparatively low current account deficits and the majority of capital inflows coming from the most "desirable" source - direct foreign investment.
However, Markus Leininger, head of corporate banking in Northern, Central and Eastern Europe at Eurohypo, who was given the job of outlining the key issues and risks for lenders in the current market, warned that the region "may be a little bit more remote, but it will still be hit" by the credit crunch.