EUROZONE: Class is no distinction

Over the summer, PERE reported how Brockton Capital had launched its second fund targeted at UK property.

Although in the past the firm has characterized itself as an opportunity fund manager, investors consider it more as a value add firm producing opportunistic-like returns, we are told.

As such, perhaps it is a good example of how the lines are blurring or possibly have become confused when it comes to distinguishing between funds labelled as ‘value added’ and those classified as ‘opportunistic’. It certainly goes the other way around as well: Opportunity funds delivering what are termed ‘value add’ returns in the mid-teens are not exactly unheard of.

The differentiation by name matters to investors in closed ended private equity real estate because a large contingent continues to make allocation-splits between them. Some do lump in value add with opportunistic in the same bucket, but many do not.

For those that do distinguish, the blurring of the lines makes it all the more important that investors look beyond the labels to really understand the basic strategies the general partners are executing, as well as their track record and quality of the teams. If you are an investor searching for a value add strategy, maybe there are some funds that have an opportunistic label that still fit, and vice versa.

But the one thing an investor most certainly cannot do is to make a distinction between funds by simply looking at the targeted returns alone. That is because there is evidence that historically returns are not all that different between funds that have the two classifications of value add and opportunistic.

Useful work in this area has just been carried out by the global secondaries firm, Landmark Partners. It finds little difference in absolute or relative performance between the two classes, at least as far as a study of 706 private equity real estate funds over the last thirty years goes. In fact, the returns between the two funds labelled value add and opportunistic resemble each other markedly.

It found that average value-added IRRs for vintages prior to 2004 were in the ball park of target returns (12 to 15 percent). Opportunistic IRRs actually appear lower on average, but the variation is not great enough for Landmark to discern a statistical difference between the average value-added and opportunistic IRRs over that period. For both classes, top quartile returns were greater than 15 percent.

Landmark Partners enlisted the help of Lynn Fisher, associate professor at the University of North Carolina, to analyze the data, and by the way, the sample is significant. It speaks for $440 billion of capital raised between 1980 and 2013, with almost one half of that committed between 2005 and 2008, and one third after 2008. It is also relevant to both the US and European markets as the sample of funds had significant focus on those two regions.

For funds with a vintage of 2004 to 2008, net IRRs to investors for the top quartile were not that dissimilar; 6.88 percent for value added funds and 7.47 percent for opportunistic.

For pre-2004 vintages, the value-added average multiple was statistically larger than the average opportunistic multiple: 1.7x versus 1.5x. Landmark also found that on average, funds raised between 2004 and 2008 have not quite returned their LPs’ contributed capital. As a testament to the variation in performance across fund managers rather than the label, top quartile funds from this period had multiples in excess of 1.25x, whereas the bottom quartile funds have failed to return 30 percent or more of invested capital.
To be fair, just because past performance has not shown a clear-cut difference it does not necessarily follow that there could not be deviation among the current and future vintages. They absolutely could, but be aware that history is against the premise.
But if the label cannot be taken as an indication of performance, then at least the two strategies do have different characteristics.

Having studied the 706 funds, Landmark Partners said the general expectation is that value added investments involve more management expertise than core products in the shape of re-leasing, repositioning or redeveloping existing assets and they may use more debt. Opportunistic strategies, meanwhile, are expected to be involved more in land and development as well as distressed properties in emerging markets with probably more leverage still. Opportunity funds basically are also expected to be riskier because they focus less on current income and are more reliant on pricing and appreciation to generate returns. They tend to be larger than value added funds and less focused on specific property types and geographies.

As investors return from their summer vacation and think about making fresh investments to funds, these are the factors they should really take note of when weighing up whether to make a commitment. After that, they can worry about the label.

The wider point would be, isn’t it right to question the overall usefulness of the broad classifications of value added and opportunistic for portfolio decisions when the variety of investment strategies is so large and the execution by managers so mission critical?