Peter Hobbs

NEW YORK CITY-In part 1 of this article, we looked at the findings of the MSCI Inc.’s bi-annual survey of asset allocation practices among pension funds and sovereign wealth funds. A complicated survey and analysis, the report, however, came to some definitive conclusions. Asset managers of these investment vehicles have developed a heightened awareness of the need for commercial real estate-specific risk management techniques and best practices. Also, to their credit, increasing numbers of these managers are trying out new concepts and theories.

The rub, though, is that many of these new theories will not be completed vetted and tested until the next crisis, Peter Hobbs, managing director of Research for MSCI-IPD tells “The jury is still out about whether they will work in times of distress like the financial crisis of 2008.”

Another issue that is becoming clear is that different investors want commercial real estate in their portfolios for different reasons-and these often diverse reasons can complicate risk management as well. Some view a real estate investment as an income-generator and inflation hedge and are content with returns of 5% to 8%, Hobbs says.

Other see it as a growth driver, especially the more opportunistic plays, and are willing to accept greater risks as a result. Then there is a middle group that wants CRE to serve all of these roles. “These investors are really prone to style drift and the risk management team doesn’t get a sense of what the investors want and what risk mitigation tactics are necessary,” Hobbs says.

All that said, some best practices have emerged and are well worth exploring.

According to the MSCI bi-annual survey these include:

Viewing CRE investments in different buckets. As noted above, CRE investors have many different motivations so a fundamental starting point for asset owners is to understand asset-specific objectives and their risk/return objectives.

Once these differences are recognized, different buckets can be created for the different risk exposures.

A better, but not complete, understanding of pricing. Many of the survey participants reported grappling with the pricing behavior of real estate and trying to compare it on a consistent basis with other asset classes. “Most feel they are not at the stage of adjusting their exposure according to the pricing of real estate, often stating that the illiquidity of real estate makes it hard to change allocations on a short term basis,” the report noted.

That said, a subset of investors—and they tend to be the largest and most sophisticated—are making explicit assessments of relative pricing when making real estate investment decisions. “These investors tend to make investment decisions relative to a multi-asset-class portfolio-wide ‘reference’ portfolio. Such investors prefer to evaluate the merits of individual investment opportunities relative to the portfolio as a whole”

Using benchmarking aggressively. If this sounds like benchmarking, that is because it is. Asset managers have many options for benchmarking—a topic about which the report goes into great detail–”ranging from absolute return measures to those based on relative performance, with relative benchmarks tending to be based on direct, fund or listed (REIT) performance.”