In the third of three pieces looking at the benefits of secondary trading of private real estate, we show the extent of the pricing and timing benefit investors gain through the secondary market compared to investing via fund queues.
- Over the last ten years, investors have traded more than £10bn via PropertyMatch. On a weighted average basis, trades have been at a discount of more than 6% to the Offer price – an aggregate saving of around £440m.
- With queues of a few months for Balanced funds and over a year for Long Income funds, instant access via the secondary market offers investors additional performance of 2-9% depending on the queue length. We estimate the benefit to investors over ten years at £550m.
- Indeed, so great is the advantage of trading via the secondary market that our trade records show that a fund investing blindly via the secondary market would have out-performed one investing with perfect foresight via the primary market in each of the last four three year periods. In other words, fund managers can only give clients best performance by using the secondary market as much as possible.
Trading via the secondary market almost universally offers a cheaper entry point than the primary market, where a premium of as much as 6% to NAV can be paid. Furthermore, by transacting on the secondary market, investors also deploy capital more quickly, receiving fund performance faster than would be the case if they entered the queue for those funds on the primary market. Fund queues can be a few months (e.g. balanced funds) or over a year (e.g. long income), meaning that lost performance can range from say 2-9% depending on fund type.
These performance benefits can be quantified to show the additional value clients have obtained by transacting via PropertyMatch, as shown in Figure 1. For the entire trading history (some £10.4bn), we have calculated the pricing benefit versus transacting on the primary market at Offer. We have also estimated the performance benefit from queue jumping. This has two components: where fund performance is known (via MSCI/AREF) or unknown (we assume identical gains to funds whose performance is known).
In total, it is likely that via £10.4bn of secondary trades clients have gained c£1bn of additional value, a benefit of 9.5% versus the primary market.
Figure 1: Secondary Market Benefits Quantified
Assumptions: Primary market pricing: We have assumed current Offer pricing where known, and 6% where unknown. Primary market length of queue: We have assumed 3m for open-ended Balanced funds, 6m for open-ended Specialist funds, and 12m for all other funds. Secondary market value through additional performance: We have extrapolated the performance of funds not contributing the MSCI / AREF by assuming the same performance as funds of a similar strategy that do contribute to MSCI / AREF. Values may not sum due to rounding.
In order to practically demonstrate the beneficial impact of the secondary market on portfolio performance, it is instructive to perform a somewhat unlikely worked example. We assume the construction of a £100m portfolio, allocated as follows: 60% UK balanced, 20% long income, 20% specialist (within which 4% each to specialist retail, office and industrial and 8% to specialist 'other'). We then work through two strategies.
- The first, 'Get What You Want', is an exaggerated caricature of a Research-led approach where the fund manager has perfect foresight and invests only in the best performing funds (£10m maximum exposure) over the three year horizon. They go via the primary market, paying the relevant premium and waiting for the length of the queue.
- The second, 'Get What You Need', is a caricature of a no-strategy approach. Here the fund manager makes no attempt to forecast performance and invest accordingly. Instead, they buy the first trades available on the secondary market until allocations are filled.
We have performed the above exercise for four three year periods from January 2013, 2014, 2015 and 2016 using actual PropertyMatch trades and actual MSCI reported fund performance.
Figure 2 chart shows the total returns earned by the two different strategies over four three-year periods. The 'Get What You Want' portfolios invest in the six, two and four best-performing Balanced, Long Income and Specialist funds after three, twelve and three months respectively. The 'Get What You Need' portfolios are assembled as and when trades come along: in almost all cases this allows entry to the market more quickly and at a discount to the offer price, although of course no preference is exhibited for funds that will perform well over the investment period.
Over all four three-year time periods, the 'Get What You Need' strategy out-performs the 'Get What You Want' strategy. The rate of out-performance is 0.7% in 2014-17 and 1.2%pa on the other three occasions. It also out-performs the benchmark in two periods out of four, by 1.0%pa (2015-18) and 0.6%pa (2016-19). The 'Get What You Want' fund never out-performs the MSCI benchmark.
In other words, even absolutely perfect fund-level forecasting (which of course is never achievable and would never be expected even by the most self-confident of Research teams!) is not enough to overcome the pricing and speed advantages of the secondary market. This outcome should have profound implications for the way in which Private Real Estate fund portfolios are constructed, with a greater emphasis on short-term tactical opportunism.
Figure 2: Investment Strategies Compared
Source: CBRE Research, PropertyMatch
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