The primary piece of research published by Oxford Economics, entitled “Listed Real Estate in a Multi-Asset Portfolio: A European Perspective” and conducted in partnership with EPRA, examined the risk-adjusted returns of model portfolios with differing levels of listed real estate exposure. It found that, on average, asset allocation and portfolio construction amongst generalist investors in Europe is suboptimal, with underweight positions in listed real estate meaning investors are failing to maximise returns on their savings.
The proportion of listed real estate in an optimally constructed portfolio varies depending on risk appetite and time horizon. Analysing portfolio performance over the recent past, the allocation to listed real estate can be as much as 10% for a risk-averse investor, while a high target-return portfolio allocation to the asset class could be as high as 25% on average. In practice, however, strategic allocations to property remain low for most institutional investors across Europe.
Indeed, Mercer’s latest survey of asset allocations for defined benefit pension plans in Europe showed an average allocation to property of just 3% (with the majority of holdings being direct). Looking across the EU, allocations ranged from zero in Spain to 13% in Italy (see figure 1). Other studies of asset allocations of European institutional investors have shown similar results. For example, a recent study by CEM Benchmarking¹ indicated that real estate allocations made up no more than 10% of pension portfolios across Europe, with the majority of holdings being unlisted.
One of the reasons for low exposure to listed real estate in Europe is that the asset class has traditionally been considered a subgroup of general equities, because shares are publicly listed and traded, leading people to believe that its performance is closely correlated with general equities. Due to this perception and focus on short term volatility, investors can have suboptimal allocation to listed real estate. As a result, investors tend to favour direct investment in real estate to diversify their portfolios.
However, this report finds that the correlation of listed real estate to equities is only “moderate”, albeit dynamic and dependent on levels of stress in financial markets. This is consistent with the findings of other empirical studies that the performance of listed real estate is comparable to direct real estate holdings over the mid- to long-term.
Speaking at the Conference, EPRA CEO Dominique Moerenhout commented, “One of the greatest puzzles for all investors is maximising returns while mitigating risk, and this has never been more important. Europe is about to face a pensions crisis due to an ageing population.” Markets such as the UK are seeing often unsustainably small contributions to pensions through defined benefit schemes as well as limited use of insurance and investment products. There are significant pension funding gaps and it is clear now that a sensible amount of exposure to listed real estate in any circumstance is beneficial to returns while diversifying portfolios and mitigating risk in the long-term. “Something has to change,” Moerenhout concluded.
The European listed real estate market has expanded rapidly in terms of size and diversity in recent years, but this study shows that investors in the region are failing to keep pace with the opportunities on offer. “Our findings demonstrate that listed real estate should be viewed as a valuable component of an investment portfolio, helping individuals to generate the best returns from their savings so they can achieve their long-term financial goals,” added Lloyd Barton, Associate Director at Oxford Economics.
In order to provide a rigorous test of whether listed real estate deserves a consistent place in investor portfolios, an ‘efficient frontier’ was created that maximises returns at varying risk levels through different combinations of asset classes (see figure 2). As the efficient frontier for a portfolio including listed real estate lies above the portfolio without listed real estate at all available levels of risk, it can be concluded that an allocation to listed real estate would have consistently enhanced the performance of the portfolio.
As a further test of the validity of the findings, portfolio performance was also modelled under a range of scenarios for the future path of the global economy (see figure 3). Testing concluded that, even in uncertain times such as a US-China trade war, optimal allocations to listed real estate remain near 10%. This pessimistic scenario assumes a further escalation of trade policy tensions, including tariff impositions affecting Europe, Mexico and China, slowing global growth and causing a fall in equity values worldwide and a slump in commodity prices.
¹ Benchmarking Inc. (2018), “Asset allocation, cost of investing and performance of European DB pension funds: The impact of real estate”, European Public Real Estate Association