Peer Intelligence | Fall 2023

By Dr. Alexander Beath, Senior Research Associate, on behalf of Chris Flynn and the CEM Research Team 

The European Public Real Estate Association (EPRA) is set to unveil its second analysis of the European institutional investor market, titled “Asset allocations, returns, volatilities, Sharpe ratios, and investment costs experienced by large European institutional investors, 2005-2021.”  As with the first analysis, the piece was prepared by CEM’s research team.   

The research updates previous CEM research on the same subject, originally published in 2018, and in some sense, a sister publication of the annual research sponsored by Nareit entitled “Asset Allocation and Fund Performance of Defined Benefit Pension Funds in the United States,” which, upon release this fall, will span 1998-2021. Because of the nature of the funded defined benefit pension market, the research largely focuses on the experience of the Netherlands, and the United Kingdom, with other European regions (e.g., Sweden, Finland, Denmark, Norway, etc.) making up a third group.  

What are the major highlights of the research? First, asset allocation trends, which can be summarized as “de-risking” post-2008 in the Dutch DB market, similar to what occurred for larger plans in the U.K. By contrast, outside of the Netherlands and in the U.K. among smaller investors, allocations have been very much “risk-on,” with increasing equity and decreasing fixed-income allocations. Interestingly, the “diversifying into alternatives” story that has been told repeatedly over the past decade-plus is in fact quite complex. For example, hedge fund allocation increased in the U.K. before dropping dramatically post 2014. Another example where “diversifying into alternatives” is not so simple is in the Netherlands, where allocations to unlisted real estate have been declining for the past 17 years. Both examples are in stark contrast to “other Europe,” where allocations to listed and unlisted real estate, private equity, hedge funds and infrastructure have all been increasing at rates that are 2x to 5x the allocations seen in 2005. 

The most important insights in the paper, however, contradict the standard issue industry mindset towards illiquid asset class returns, which has been one of diversification and low volatility compared to listed assets such as stocks and bonds. This story will be familiar to long-time followers of CEM research. 

Indeed, over the past few years, it has become recognized that differences between listed and private market returns (e.g., listed vs. private equity, listed by private real estate) are, for the most part, simply accounting differences. Where listed markets are marked-to-market, private markets are valued on appraisals. Once the differences between valuation methods are taken into account (lag, leverage, smoothing), listed and privately traded versions of specific asset classes are revealed to be highly correlated, with privately traded versions typically showing higher volatilities, higher investment costs, and more leverage. For some asset classes like equity, privately traded investments also come with higher returns, often because of the use of more leverage. For other asset classes like real estate, returns for private market assets can be worse than those of listed assets.  This can be attributed primarily to differences in cost (e.g., real estate in the Netherlands and the U.K.). 

Truly unbiased return comparisons are, however, very difficult to accomplish. Comparisons of listed and private equity suffer from differing sector tilts, while listed and private real estate comparisons suffer from differences in geographic exposures (among others). Long term correlations are relatively agnostic to these differences, and standardizing returns to put listed and privately traded assets on the same mark-to-market footing shows that listed and privately traded assets are far more correlated than commonly understood. If you were building a $200 billion portfolio for the benefit of hundreds of thousands of pensioners, wouldn’t you want to know the real correlation between one investment and another? 

Dr. Alexander Beath presents: “Asset allocations, returns, volatilities, Sharpe ratios, and investment costs experienced by large European institutional investors, 2005-2021.” at the annual EPRA conference in September.