REITS: Zooming in on CORE exposures
Constructing efficient allocations entails detailed analysis of a multitude of dimensions and options and while the process of seeking specific outcomes is mainly driven by expectations, which can be broadly categorized into areas of risk, return and probability, investors have the possibility to define allocation structures and control cost efficiency at the outset.
In the case of actively managed global real estate securities funds, one particular aspect of portfolio construction, in our view, presents investors with important inefficiencies which can be improved at the outset. Namely, the skew in active profile. We have commented on this subject previously and readers interested in background information can find more details in the following REITS: Unleashing alpha returns and REITS: Active managers' dilemma lies in mathematical impossibilities and opportunity costs. As a general point, although actively managed funds in the sector have on average reached a level of 50% active share, i.e. the level at which on average there are no negative expected alpha positions, this average figure is not consistently equal throughout the opportunity set of the benchmark, but instead is subject to a meaningful and systematic skew. Active share utilization is consistently relatively low in approximately the top 1/3rd of benchmark constituents which define the opportunity set to pursue alpha generation, thereby creating a consistently 'inactive' segment. The break-even point of reaching full active share utilization is at approximately the mid-point of benchmark by market-capitalization. This is a general feature across the sector with well known issues of low active share as a result.
The implications are that the inclusion of negative expected alpha positions translate to a lower potential to contribute to excess returns sought from active allocations. Negative expected alpha positions also imply opportunity costs related to returns that potentially could have been achieved had a portfolio been consistently active throughout the opportunity set. Put differently, negative expected alpha positions can be seen as creating a structural performance drag in this part of portfolios at higher relative cost associated with active management. The performance drag is not in relation to the benchmark but rather in relation to the process of active management which can be expected to seek to maximize alpha generation opportunities.
Introducing CORE Index
Kania Global Real Estate CORE Index seeks to isolate the 'inactive' segment of actively managed portfolios from the fully active segment. The CORE Index can help to improve benchmarking of processes and practices, measure performance that is subject to structural alpha generation limitations, measure contribution to overall performance and provide an option to define alternative allocations in the sector.
The chart below illustrates the segment that CORE Index is composed of.
Summary of methodology for CORE Index
The index is designed to provide a core exposure to global real estate securities through a structure which identifies and isolates a part of the market-capitalization weighted benchmark for which, on average, actively managed real estate securities funds with global focus do not achieve a fully active profile of at least 50% as measured by active share. Index constituents are market-capitalization weighted. The index is rebalanced on a semi-annual basis, at the end of June and December.
CORE is a proprietary index calculation methodology of Kania Advisors.
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.