Benchmarking is no longer a one-size-fits-all proposition. In fact, a white paper released by research firm MSCI this week questions whether investors are using the appropriate benchmark in the first place.
While broad-market indices are widely used, for example, they are best-suited for investors that can invest directly in assets. Other investors, meanwhile, can benefit from using more focused peer-group indices that assess performance at the fund level, asset level or even tenant level.
Using a more focused benchmark – which results from first determining a clear investment strategy and then a relevant risk-return profile – therefore can help investors better align teams and avoid inaccurate comparisons between portfolios and markets. Will Robson, global head of applied real estate research at MSCI, told PERE that misalignment can lead to undue punishments or rewards for managers and investment teams. “It can cause governance failures where responsibilities aren’t clear,” he said.
Using the appropriate benchmark goes hand in hand with making more in-depth performance assessments. Indeed, there are now myriad ways benchmarks can be used to monitor performance, set targets and better understand market movements.
As real estate has become integral to most institutional portfolios, investors can no longer justify the “set-and-forget” mentality that was once pervasive in the asset class, the report notes. While annual returns might meet or beat absolute targets, an investor that simply accepts them at face value loses the opportunity to gain crucial insight on its property portfolio.
For instance, an investor can learn more about the performance of their investments through attribution analysis, which isolates the various components of a return, such as property value, leverage and segment allocation. Such breakdowns spell out why an investment is or is not performing as expected and informs the investor about how to approach decision making in the future.
Unsurprisingly, investors are often driving the conversation on benchmarks and in some cases, crafting their own evaluation tool sets. Those with the ability and wherewithal can use their findings to optimize their investments and investment teams.
One European gatekeeper tells PERE its investors have taken a keener interest in what indices it uses to evaluate its investments, asking why one benchmark is used over another. The California State Teachers Retirement System, meanwhile, has 512 benchmarks across asset classes to measure investment performance, according to its March 28 meeting documents. That number is expected to increase as CalSTRS adds more strategies to its portfolio.
MSCI is attempting to meet this demand for greater benchmarking by giving investors the ability to layer indices on top of one another, tracking asset-level, sector-specific and regional performance. Other research firms are also coming up with ways to delve deeper into performance numbers. INREV launched a pan-European asset-level index last month and NCREIF is working on new products as well. Larger, more sophisticated investors are using bespoke indices to benchmark performance.
Opaqueness and asset variability are longstanding hurdles to assessing the private real estate market but those challenges have been addressed partly by advancements in technology and a growing willingness among investors to share performance figures with third parties. But while comparison tools now offer more insight into investments, there is still room for improvement. Standards are only as reliable as the data behind them and in a private market, that depends on these voluntary disclosures.
Also, investors chasing niche strategies may find comparable peer groups hard to come by and indices that do exist come at a cost. Even investors that share performance figures with firms such as MSCI and INREV must pay to access it in aggregate.
While there is work to be done to optimize benchmarking, the proliferation of available benchmarks alone is a move in the right direction for the market. As real estate matures as an asset class, it is only appropriate that the tools used to shape it do the same.
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