REITS: Will the real unique manager please stand up...
The first and most important property of constructing an investment portfolio is diversification. Investors often model and construct exposures utilizing more than one product even for a relatively narrowly defined target allocation such as a sector. The aim is to achieve additional diversification as more than one option may be attractive and provide the exposure that is sought but may also offer differentiating product structures, investment approaches or expertise and reduce concentration risks. It may therefore be beneficial to analyse various dimensions of potential options to achieve optimal diversification.
One such dimension that may be relevant to evaluate is the correlation of active positions relative to the benchmark against which an allocation is constructed. This can provide detailed insights into how similar or different potential or actual exposures are across products, investment approaches, managers etc. As an example, an investor may wish to award a mandate to more than one manager to benefit from different expertise or may wish to split a mandate between an active and a passive product or alternative beta product, etc. If the aim of combining exposures is to achieve more efficient diversification in the overall allocation then if the separate options under consideration ultimately produce correlated portfolio results it may reduce the expected diversification benefit of that particular combination; e.g. if two active managers overweight and underweight similar stocks at similar times in a systematic way, i.e. take similar active positions, that would reduce the diversification benefit of combining solutions of those particular managers, or the same reasoning applied to any option under consideration.
One way to evaluate this diversification effect is to consider pair-wise correlations of the direction of active positions compared to the relevant benchmark. This can give an indication of the degree of similarities in ultimate portfolio structures with respect to benchmark constituents which define the investable universe for the allocation.
The chart below illustrates pair-wise correlations of the direction of active positions (over- and underweight) among actively managed global real estate securities funds along with the same done for index constituents of KARECAITU (Kania Global Real Estate CAI Index) compared to the funds' active positions. As the chart illustrates, the pair-wise correlations among the funds are meaningfully and consistently higher, with an average of 0.68 and 0.75 for the 90th percentile, while comparing active positions of KARECAITU to any fund's active positions produces both lower and narrower band of pair-wise correlations (randomly drawn active positions would have a pair-wise correlation of 0.50).
This implies that even for investors who have a preference for actively managed solutions, it may still be more beneficial from a diversification perspective to include alternative beta solutions together with actively managed ones rather than combining any number of actively managed solutions only, when constructing overall allocations to global real estate securities.
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About Kania Advisors
Kania Advisors is an independent research and advisory firm focused exclusively on institutional real estate allocations and investment programmes. We provide advice and solutions to improve outcomes in real estate investment programmes. We conduct detailed industry research and custom studies typically focused on quantitative analysis and provide insights which form a critical part of a client's decision process.