Covid-19 is challenging the future for sector-specific funds

Sector-specific funds could bear the brunt of coronavirus-induced market uncertainty as investors opt for the flexibility and diversification provided by multi-sector vehicles.

Since covid-19 started disrupting capital markets, real estate investors have been forced to re-examine their allocation and investment approaches. Sector-specific funds are one aspect of fundraising that face an uncertain future in this recalibrated world.

In a webinar this week, Alisa Mall, director of investments at the Carnegie Corporation of New York, talked about how the foundation is thinking about increasing its exposure to managers that “can play up and down the capital stack.” The foundation had previously typically favored small, specialist managers, but the potential distress opportunities expected in a recessionary environment is prompting Mall to re-evaluate that thesis.

Her line of thinking will resonate with other investors. At a time of unprecedented uncertainty – about the duration of the current health crisis, its economic fallout and which real estate sectors will outshine – why would investors choose to lock their capital in one sector. Instead, diversified, multi-sector funds wherein managers have the flexibility to rejig investment strategy and take advantage of market conditions could be more appealing. An opportunistic fund that can be deployed in both equity and mezzanine debt investments, or a diversified core fund, might well be better fits for investor’s needs, for example.

Sector-specific funds were already losing luster among investors pre-covid-19. This current climate will only further exacerbate the situation. In PERE’s 2020 ranking of the top 100 global real estate managers in the higher risk and return strategies, set to be published soon, only 13 firms operate sector-specialized funds.

According to PERE’s Q1 2020 fundraising data, there were only eight sector-specific funds raised in the first quarter. There were no retail or office funds. In fact, 75 percent of the $30.7 billion in aggregate fundraising during the period was for sector-agnostic funds, the highest percentage since 2014.

Toward the lower end of the spectrum, performance of retail, hotel and residential properties have also been underwhelming compared with the overall, multi-sector, NCREIF Property Index. In Q1, for example, the total return of the index, reflecting investment performance for 8,445 commercial properties totaling $683 billion of market value, was 0.71 percent.

In this period, hotels recorded a negative 3.86 percent return while retail was at negative 2.06 percent. Meanwhile, the index’s one-year return stood at 5.28 percent, while apartments, hotels and retail were 5.1 percent, negative 0.7 percent, negative 1.9 percent, respectively. Logistics was the only traditional sector to buck this trend. The sector posted 2.58 percent returns in Q1 2020 and 12.9 percent over a one-year period.

However, there is a question of whether managers will opt to raise capital for logistics via separate accounts and joint venture partnerships, instead of commingled blind-pool funds. Whatever the preferred vehicle type, the exponential surge in e-commerce activity post-outbreak has amplified the structural demand for logistics and warehouse facilities globally. In China, several firms including New York-based JPMorgan Asset Management, Hong Kong-based Baring Private Equity Asia and the London-headquartered Actis, have reportedly launched China-focused logistics ventures in the past month.

But should the logistics sector get overheated too, only mega managers, with well-established track records, will emerge as winners in this sector-specific fundraising battle. In any event, skirmishes for attention at the sector-specific level stand to be a sideshow to a main event now rooted in multi-sector strategies thanks, in part now, to the pandemic.

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