Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
… and a cautious note on RE debt
Bfinance, the fund management search and research firm, has sounded a word of warning for big investors looking to select a manager for the burgeoning asset class of real estate debt.
In a note to clients published last week (May 26), Trevor Castledine, bfinance senior director, private markets, says funds are using five key levers in their search for results. They are:
1. Increase LTV ratios
2. Change the collateral
3. Add leverage
4. Look to under-served geographies, and
5. Seek distress.
“Investors who are prepared to take on still more risk will find an increasingly wide variety of offerings which include punchier strategies,” Castledine says. Some of the higher-yielding strategies can provide investors with returns, net of fees, of 7-10 per cent a year, “if not more”, he says.
“Crucially, investors must ensure that extra yields do not come at the expense of disproportionate increases in risk by understanding which approaches the manager is using to deliver an enhanced return.”
Some of the levers have been popular for years, such as mezzanine debt and higher LTV ratios (whole loans), which have long been used to provide outsized returns. This trend was true even before the GFC.
Others are becoming more widely used in today’s climate, such as newer strategy types which are more likely to tap into specific niches, including smaller properties, riskier geographies, distressed assets and development or bridging finance.
The report is based on bfinance’s global experience, including its presence in Australia where the firm has been involved in several specific searches for real estate debt managers in the past three years.
“bfinance sees a number of different players now active in the higher-yielding real estate debt space,” the report says. “For example, the 2009-11 period saw teams emerge from the banking world, where they could no longer manage their product amid new regulations, and setting up their own fund management businesses. Many of these start-ups have grown and now have institutional quality teams and attractive track records.”
More recently, the firm has seen core senior lenders moving towards the higher-yielding parts of the market, as well as real estate equity managers who have spotted a gap on the debt side and moved to take advantage of the opportunity. Meanwhile, some corporate debt managers are adding real estate secured debt to their stable.
Most of the “levers” used require “very specific” knowledge, experience and resources, Castledine says. Managers are frequently using a combination of approaches to enhance returns, making the strategy more complex.
