Demand is growing for real estate ETFs

But while the UK property market is booming and property indices around the world are delivering strong returns, real estate is still, in many cases, a real asset of bricks and mortar that can be illiquid and difficult to buy and sell.

So is active management really the best way to approach the asset class?

In investment terms, where the institutional market leads the retail industry tends to eventually follow, and an interesting trend has been highlighted in the latest European Asset Allocation survey by Mercer.

The findings show that in the uncertain environment, many institutional investors are reconsidering their alpha (active strategies) and their beta (passive approaches). As a result, the survey shows the use of passive management within traditional equity and bond portfolios has increased, with the average pension scheme investing 49 per cent of its equity assets passively, up from 45 per cent in 2014.

Meanwhile, passive investing in bonds for the average scheme increased from 37 per cent to 44 per cent of assets.

Phil Edwards, European director of strategic research in Mercer’s Investments business, explains: “Our findings suggest that investors may be redeploying active management risk budgets towards alternatives portfolios. However, there is a considerable variation in behaviour by plan size and governance budget, with larger investors exhibiting a greater use of active management across all parts of their portfolios, alongside a tendency to invest via less-constrained mandates.”

So does this mean alternatives such as real estate do better with an active approach?

The number of passive property vehicles – primarily real estate exchange-traded funds (ETFs) listed in the Global ETFs category on FE Analytics – is just 29, a much smaller group compared with the 46 members of the Investment Association Property sector, while there are 24 trusts listed across five Association of Investment Companies Property sectors.

But with iShares launching two property ETFs this year – the iShares MSCI Target US Real Estate Ucits ETF and the iShares MSCI Target UK Real Estate Ucits ETF – the choice for investors is growing.

Tom Fekete, head of product development, Europe, Middle East and Africa (EMEA), at iShares, says: “Until recently, the only real estate ETFs available were those providing exposure to Reits [real estate investment trusts]. While they provide exposure to the property sector, they can also show significant correlation to equity markets and the volatility associated with them.

“We are already seeing strong demand from clients and [real estate ETFs] are being used in a variety of ways. For example, property managers are considering them as an alternative to some of the cash weighting in their portfolios, while retail investors like that they can instantly access an asset class that has traditionally been expensive and difficult to access.”

But not everyone agrees. The characteristics of property mean it remains an active asset class for many.

Graham Porter, head of UK property research at Aberdeen Asset Management, says: “In the UK, attempting a passive strategy is counterproductive, if not impossible, because it often means stock selection is approached less rigorously. Even an indirect strategy cannot fully replicate market performance, especially when leverage is involved, because real estate is a heterogeneous asset class – each asset is unique.

“Performance is derived at the asset level, through diligent stock picking and specialist asset management skills that realise an asset’s potential.”

When making the choice of whether to go active or passive, it seems the key issues to consider are liquidity, costs and whether you want synthetic replication or real bricks-and-mortar assets.

Michael Mohr, head of exchange-traded product development, EMEA, at Deutsche Asset & Wealth Management, adds: “Funds, and particularly ETFs, solve that liquidity issue. Funds are also easy to invest in, while the buying and selling of physical property is heavy on transaction costs, and on time and effort.”

But he points out: “Property ETFs invest in Reits. When you invest in a property ETF, the exposure you get is different to holding physical property as a buy-to-let investor would. The exposure is to a diversified portfolio of listed commercial property companies, and the performance of those will have some correlation with the broader equity market.”

Nyree Stewart is features editor at Investment Adviser