Commercial real estate’s risk /return profile may be attractive to a variety of institutional investors. Investors may be seeking a diversification effect to their total portfolio; a stable income stream from rent, or inflation protection and expected capital appreciation over the long term.
But creating an index that replicates performance of a direct real estate index and is replicable on a daily basis is notoriously difficult because real estate transactions occur only occasionally and properties are appraised periodically. The MSCI USA IMI Liquid Real Estate Index aims to offer an innovative tool for investors seeking a more liquid benchmark for this important asset class.
So how is it different? The MSCI USA IMI Liquid Real Estate Index seeks to mimic a direct real estate index by adjusting for the differences in volatility and leverage between listed and private real estate. The index reweights the securities of the parent index with an aim to reduce volatility and deleverages the index with a goal of inflation protection. Starting with a core real estate index, we first seek to reduce volatility by applying a tilt factor methodology, over-weighting less volatile securities and under-weighting more volatile ones. Then we deleverage the tilt index by combining it with an index of short-term bonds.
This new index aims to combine the best features of direct real estate indexes (more accurate measurement of the asset class) and listed real estate indexes (more responsive valuations, greater transparency and investability). At the same time, the liquid index is designed to correct for their disadvantages. Unlike the direct real estate index, the index is designed to be replicable and liquid. And unlike the listed real estate index, the new index backs out leverage taken by real estate companies and has offered lower volatility and a lower correlation with the equity market.
In the below graph, the MSCI UK IMI Liquid Real Estate Index more closely tracked the performance of the IPD UK Quarterly Property Index (a direct property index) than the MSCI UK IMI Core Real Estate Index during the period between June 2001 and June 2014..
Despite the similarity in historical performance, the MSCI UK IMI Core Real Estate Index is not intended to be a complete substitute for direct real estate benchmarks. Instead, the index aims to provide a new way to benchmark commercial real estate. The index has been designed to help institutional investors with a portfolio size that does not allow them to invest in direct real estate or those seeking an exposure to real estate with higher liquidity.
To read the full paper, “MSCI Liquid Real Estate Indexes,” click here.