Performance is in the eye of the beholder

Listed managers appear to have some of the best track records in the industry, but given how widely valuation methodologies can vary, returns do not always tell the whole story.

Question: What do two of the following three funds have in common: Brookfield Strategic Real Estate Partners III, Starwood Global Opportunity Fund XI and Blackstone Real Estate Partners Asia II?

Answer: Two of the three funds – the largest vehicles to have closed or are expected to close in 2018, according to PERE data – are sponsored by publicly-listed managers.

This is not necessarily a coincidence. At a time when a handful of real estate managers are raising most of the capital in the market, investors are opting to invest with these managers partly on the strength of their track records, and listed managers are generally considered to have some of the best in the industry. Blackstone, for example, was generating a total net internal rate of return of 16 percent and a multiple on invested capital of 1.9x across 15 real estate funds as of 31 December, according to its most recent earnings results.

But relative performance results reported by listed managers can be misleading. According to a new report from New York-based real estate advisory firm Hodes Weill & Associates, some listed investment managers are marking valuations to market earlier for their unrealized investments in closed-end funds. These more rigorous marks help public managers recognize gains on an accelerated basis and in turn help enhance the valuation of these listed firms’ shares.

By contrast, private real estate managers, particularly boutique firms, may take a more conservative approach to valuations, typically holding assets at cost for a few years before recording any appreciation in value. Because of their lower projected returns, smaller managers’ funds may appear to be underperforming next to their listed counterparts.

Such a discrepancy in valuation methodologies has become more apparent as more fund data have become available in the market. In the 10 years since the global financial crisis, many managers have raised multiple funds, some of which are now fully liquidated, providing investors with a consistent pattern of returns. While a fully harvested fund will have realized performance numbers, the vehicle will likely be of a vintage from several years ago. Consequently, when evaluating potential commitments, investors also will want to look at a firm’s more recent funds and consequently at the manager’s unrealized track record.

One listed manager told PERE this week that quarterly valuations are just estimates and realized returns are what matter most. Indeed, once a fund is fully liquidated, the realized returns of both large listed managers and smaller private firms pursuing similar performance targets ultimately converge, according to Hodes Weill. Assuming both the listed and private managers exceed their return targets, outperformance in the later years of the fund may be greater for the private firm, given its more conservative valuation approach in the early years.

But when it comes to fundraising, investors are making commitment decisions largely on the more recent, but unrealized, performance data. Indeed, the listed manager considered the valuations that the firm used for fundraising purposes to be “optimistic,” while he personally felt that valuations should be more prudent and “realistic,” allowing for a margin of safety.

It is not hard to see why this might aid listed managers in  capturing the lion’s share of the fundraising market, while many boutique managers struggle to compete and raise capital.

Of course, track record is not the only reason why large managers achieve massive equity hauls. Scale, for instance, is another important factor for some investors, given the current trend among capital providers to invest with fewer firms. But given the discrepancy in how managers arrive at performance data, it is important for investors to consider the listed/non-listed status of a manager when evaluating commitments to ensure they are reading performance numbers in the right context.

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