European Real Estate Society Annual Conference Vienna 2013 Real Estate Fund Active Management by Stephen Lee Cass Business School, City University London and Giacomo Morri SDA Bocconi School of Management

Introduction Active Management: 1.Uses manager expertise; 2.Different investments from benchmark; 3.Expensive; 4.Lacks diversification; 5.Incurs “‘incidental’ risk and ‘intentional’ risk. 6.Problem “closet index” funds Passive Management: 1.Replicates index 2.Should be inexpensive 3.Diversified 4.Should only incur ‘incidental’ risk but this is difficult to do, especially in real estate market.

Two Dimensions of Active Management Traditional method: Alford et al (2003) -tracking error New method: Cremers and Petajisto (2009) -Active Share Complete picture: -tracking error and; -Active Share

Two Dimensions of Active Management

Research Design Closely follows that of Cremers and Petajisto (2009): 1.One benchmark portfolio 2.Property data alone 3.Hybrid measure of Active Share: 4.Tracking error: 5.Nine-year average Active Share 6.Compare returns

Fund Data 38 UK real estate funds with complete return and market segment data – all “active” funds Period from Q4:2003: to Q4: Specialist and 20 Balanced Balanced expected to be index funds; Specialist funds expected to be “diversified stock pickers” or “concentrated stock pickers”.

Fund Classification

Table 1: Rank Correlation between Tracking Error and Active Share across Sub-periods Fund Classification

Table 2: Return, Active Share, Tracking error, Size and Leverage: Overall period Returns V Active Management

Table 3: Return, Active Share, Tracking error, Size and Leverage: Sub-periods Returns V Active Management

Table 4: Correlation: Return, Active Share, Tracking error, Size and Leverage

Conclusions First, the approach is able to classify real estate funds in the UK on their management activity into categories that makes intuitive sense and seem stable over time. Second, Balanced funds show relatively low Active Shares and particularly low tracking errors, due to the benefits of property-type diversification. Specialists funds display higher Active Shares and both high and low tracking errors depending on their stock picking approach: diversified or concentrated. In other words, the fund classification scheme of IPD does a respectable job in identify the fund types (Balanced and Specialist).

Conclusions Next, the performance of the different management strategies varies with diverse market conditions. Active funds that use a lot of leverage and demonstrate stock-picking ability can add value, especially in boom periods, whereas “index” funds which use little or no leverage show consistent but low returns all the time. This implies that investors need to constantly monitor changes in the market and switch between fund management styles, if at all possible.

European Real Estate Society Annual Conference Vienna 2013 Real Estate Fund Active Management Any Questions?