The MSCI Private Real Estate Factor Model
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The rise in allocations to private asset classes has brought about two major challenges for asset allocation and risk management. The first challenge is the need to put private assets on an equal footing with the total portfolio to understand their contribution to total portfolio risk, and inform like-to-like capital market assumptions. The rise of the total portfolio approach (TPA) makes this all the more important.
The second challenge has been brought on as many investors explore a broader opportunity set in global real estate. Real estate investors who have traditionally had a home bias increasingly seek diversification and value abroad.
Both of these challenges point to the need for a risk modeling framework that is broad in both asset class and geographic scope. Traditionally, this has been limited by a lack of information. Private real estate valuations are scarce, and smoothing distorts the apparent risk and cross-asset-class correlations.
The MSCI Private Real Estate Factor Model consists of a suite of models and features:
- A Bayesian desmoothing methodology provides robust risk estimates from limited data sets
- Coverage spanning 31 countries across five continents
- A global property-type classification system allows like-to-like comparisons across markets
- Four hundred factors covering property type by region
- Coverage of farmland and timberland in the U.S. and U.K.
- Income return factors, distinguishing rental income from capital appreciation
- Property sub-type and metro area granularity in the U.S.
- Granular property sub-type factors in the U.K.
The annualized volatility and beta of private assets rise significantly with the return horizon, in contrast with equity and listed real estate. A simple √T scaling to annualize the volatility leaves the public equity and listed real estate curves basically flat. However, the upward slopes in the private asset curves indicate that the short horizon returns are smoothed, and do not capture the true long-run risk of these asset classes. Note that Private Real Estate is unlevered, while the other time-series include leverage: the slope may be consistently compared across asset classes, but not the level of the curves. Source: MSCI, NCREIF
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