The recent headlines in the financial press regarding the sharp fall in the value of Blackrock shares (Blackrock: a vast money machine splutters – FT 19/10/2018) may seem like distant thunder to many in the UK commercial real estate sector but the implications for the sector could be very real indeed.
Chart 1 – BlackRock Inc. – US$ Share Price – 6 Months to 24/10/2018 (Source: Bloomberg 24/10/2018)
According to the FT, BlackRock’s long-term net flows – a measure of how much money investors are handing it, excluding more short-term volatile cash management vehicles – dropped to US$10.6bn in 3Q2018. If you include all flows then this means that BlackRock effectively suffered its first quarterly investor withdrawal since the market crash of August 2015.
Inevitably the root cause was cited as unstable financial markets and nervous investors – i.e. this was just a “temporary setback”. So, nothing to be concerned about?
That may be part of the reason but on closer inspection the picture is a potentially a lot more complicated than that. Leaving aside the fact that financial markets ARE highly volatile right now and investors ARE justifiably nervous the global fund management industry is undergoing something of a fundamental restructuring. One of the key drivers of change is the intensifying pressure on fees from cheap index tracking funds which have sucked in hundred of billions of dollars since 2008. Not only has this created a race to the bottom – Fidelity recently launched the first free index tracking fund – it has also highlighted how much investors have historically paid for active strategies and other specialist vehicles such as real estate.
According to the Investment Company Institute, the average costs of US bond and equity funds has fallen from 0.76% and 0.99% of AUM in 2000 to 0.48% and 0.59% of AUM in 2017. The reason for this of course is technology. Put simply, passive investment strategies can be delivered by computers and algorithms which don’t need high salaries, office space and personal pension pots. They are happy and able to deliver stable attractive risk adjusted returns by using the available market data to formulate investment decisions.
Chart 2 – Cumulative flows into passive vs. active funds (US$mn) – 2009 to 1H 2017 (Source: Strategic Insight SimFund, BofA Merrill Lynch US Equity & US Quant Strategy0
The commercial real estate sector has largely ignored the noise coming from equity and bond markets in this regard. Indeed, many asset managers have deliberately targeted real estate and other real assets in recent years precisely because they are fundamentally active investment strategies that require specialist skills and highly localised market knowledge. In short this means they can charge higher fees to investors.
Well it can probably be best described as the “real estate investment market information deficit”. Even the most rudimentary analysis of the commercial real estate sector would reveal that the term “property market” is a misnomer. There is no functioning market or universal pricing mechanism as each transaction is unique and the market is only created at a point in time between the buyer and seller. Compare this with equity and bond markets where the “price” is a function of multiple sources of “live” demand. More importantly there is no “inside information” so all parties invest based on regulated disclosure of information.
Many see this “information deficit” in the real estate sector as the opportunity. In most cases investors are asked to invest blind into a property fund without any detailed knowledge of the true risk/return on offer. The industry uses subjective terms like “core”, “core plus”, “value-added” or “opportunistic” without any reference to any empirical evidence supporting the risk-return trade off.
Ask a property fund manager for a detailed breakdown of the assets in the fund, their performance history, projected returns, the credit rating of the tenants and the projected cashflows and you will often be met with a black stare or worse. In most cases, disclosure is avoided because it’s seen as losing an advantage but the reality for many funds is that they simply don’t know the answers to those questions and compiling the data could take several weeks to achieve. This inability to access data and analyse it in any meaningful way lies at the heart of the “information deficit” in the property sector. While that may look like an advantage to the fund manager it is not necessarily in the best interests of the investor or market liquidity in general. Indeed, it’s this lack of information that has perpetuated the “Arthur Daley” image of the property industry with some institutional investors.
Firstly, the real estate investment fund management industry needs to realise that just like equity and bond fund managers that they are in the data business and NOT the property business. The real estate is simply a means of recycling the capital to achieve a required target return. It is not an end in itself. Ergo they are selling market knowledge and expertise to their clients so a detailed knowledge of their portfolio, tenants and the markets in which they are invested is the most important asset they possess.
Secondly, in a world of rapid technological change real estate fund managers are competing for the attention of asset allocators against equities, fixed income and other alternatives. Allocation decisions will increasingly be driven by computers and algorithms not human intervention. If the data on the sector is not available or simply not fit for purpose, then real estate will simply not get an invitation to the ball.
Thirdly, fees in the real estate sector will continue to come under pressure, so property fund managers need to find a way to reduce costs and streamline their business processes. A great deal can be achieved by reducing time to market for reporting and the management of data assets. Other sectors have already been through this process and reaped the rewards by effective use of technology.
While the technology issues shaking up asset managers in the equity and bond markets may look like someone else’s problem the real estate industry needs to be thinking very carefully about the long-term implications for its own market. The last crisis showed us that all markets are inter-related and changes in one tend to ripple through into others, sometime in unexpected ways.
While the very nature of the sector precludes the emergence of passive investment strategies the lack of disclosure could prevent the real estate fund management industry as a whole from having a seat at the table when asset allocation decisions are made further up the chain of command.
Didobi advises clients on how to have data fit for purpose and provides independent advice through a data and platform agnostic approach. Didobi comes from the needs of the client and works back rather than from what a client has and then work forward.