Blending the Real Estate Allocation - StepStone Group
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Blending the Real Estate Allocation
Much of the asset allocation work in relation to institutional
commercial real estate (“CRE”) centers on the assumption
that it is either a private market equity (“PrivEq”) allocation or
for investors with a greater liquidity focus—an allocation to
listed market equities (“LisEq”) such as REITs. There is much
less available research seeking the performance and risk
implications of portfolios composed of PrivEq and LisEq as
well as private market debt (“PrivD”) and listed market debt
(“LisD”) strategies—Blended Real Estate (“BRE”). Increasingly,
however, we see portfolios that need both the incremental
return of private markets and the potential for liquidity of
listed markets. For example, defined contribution (“DC”)
pension plans in the UK and US are required to provide
liquidity on a daily or monthly basis. This creates a need for
real estate portfolios to include at least a modicum of listed
market exposure.
September
STEPSTONE |2017
Blending the Real Estate Allocation 1To demonstrate the potential for BRE to address this situation, » Current Income—Due to the cash flow aspect of CRE,
StepStone has sought to quantify the benefits and costs. current income is a large component of the total return.
The objectives of this study are four-fold: This has historically provided investors with a competitive
absolute return relative to other asset classes and a good
To demonstrate the longer-term performance and
1
liability matching potential; and
risk characteristics of BRE portfolio strategies, both in
» Hedge for Inflation—Lease rates often contain annual
isolation and in a multi-asset context;
increases and can provide a good inflation hedge in the
To provide a brief discussion of certain, often overlooked,
2
portfolio. Over the long-term CRE, rents and consequently
statistical considerations when incorporating private values trend with construction costs, which themselves are
markets1 asset classes in an asset allocation framework;
highly correlated to broader measures of inflation.
To analyze portfolio risk characteristics using a measure Institutional investors have four primary investment conduits
3 that is better than volatility in accounting for both
downside risk and the performance characteristics of
private markets asset classes such as real estate; and
through which to gain CRE exposure (Figure 1). These ”four
quadrants” can be accessed through a range of holding
structures including direct ownership and management, or
To provide clarity on the risk allocations to various indirect exposure through funds (e.g., limited partnerships)
4 exposures as opposed to just showing the capital
allocations to asset classes that is often presented.
and other investment vehicles. Investors are often invested
in more than one of these quadrants; in StepStone’s view,
institutional investors should consider their allocation across
The current discussion focuses on real estate allocations, but multiple quadrants if they are not already.
we are also working more broadly on strategic asset allocation
across alternative private markets strategies. This paper is Listed Markets Real Estate Investments
therefore the first in a series on the topic of asset allocation
» LisD—Listed market real estate debt consists primarily
and risk measurement that we expect to bring forth over the
of mortgage backed securities that are typically held in
coming quarters.
institutional bond portfolios.
» LisEq—Listed market real estate equity consists primarily
The Many Benefits of Commercial Real of Real Estate Investment Trusts (”REITs”) or operating
Estate and Investment Options companies whose core businesses focus on real estate
Institutional investors understand that CRE can be a beneficial construction, operation or investment.
component of a multi-asset portfolio. The merits for
Private Markets Real Estate Investments
incorporating a CRE allocation include the following:
» Low Correlation—CRE investments typically have a low » PrivD—Private mortgage loans and mortgages are typically
correlation with traditional asset classes, particularly LisEq. held by insurance companies or are a component of large
Thus, CRE acts as a good "diversifier," helping to reduce institutional private credit portfolios.
overall portfolio risk. » PrivEq—The most common vehicle for institutional
» Less Volatility—PrivEq assets are valued less frequently, investors, private equity real estate can take the form of
so their impact on the overall portfolio will be reflected direct ownership, commingled funds, joint ventures and
gradually over time. separate account structures.
1
In this paper, we use the term private markets to refer to private real estate markets; many of the observations we make apply equally to other private markets
strategies such as corporate private equity, private infrastructure and private real assets.
2FIGURE 1 | THE FOUR QUADRANTS OF INSTITUTIONAL COMMERCIAL REAL ESTATE
Listed Private
Listed Market Debt (“LisD”) Private Market Debt (“PrivD”)
Debt Fannie/Freddie, CMBS, CMO Senior/Whole Loans
YE16 Size: US$1,352 billion YE16 Size: US$2,541 billion
Listed Market Equity (“LisEq”) Private Market Equity (“PrivEq”)
Equity REITs Directly held assets, LPs, LLCs,
YE16 Size: US$960 billion YE16 Size: US$851 billion
Source: PREA, Q4 2016.
Commercial Real Estate Investment risk profiles, potentially skewing the results of a typical asset
allocation model.
Performance Characteristics There are generally two main approaches to address this
To assess the performance characteristics of CRE we use a issue: statistical “unsmoothing” methods;2 and correcting
sample of well-known benchmarks for the US. The US is the for smoothing in the appraisal data by using transactions
only market for which there are recognized performance based indices. Transaction based indices measure real estate
indices available across the quadrants that have a long, robust performance using the prices of property assets that are
historical series. bought and sold in the private market. This methodology
PrivEq is represented by the National Council of Real Estate is therefore not reliant upon interim valuations to measure
Investment Fiduciaries Property Index (“NPI”). The NPI periodic total returns. Rather than select an appropriate
measures the direct unleveraged performance of operating statistical unsmoothing methodology for this study, we
US property assets held in private, institutional real estate use the NCREIF Transaction Based Index (“TBI”) to represent
portfolios and thus, should be considered as a Core private unsmoothed private equity performance. The methodology
equity exposure. The performance of the assets, both values used to construct this index is detailed in Fisher et al (2007).
and cash flows, is collected directly from institutional investors Like the NPI, this index measures the direct unleveraged
performance of institutionally held US CRE assets.
or their real estate investment fiduciaries. The reported values
used to construct this performance index are based on market LisEq is measured by the FTSE-NAREIT US All REITs Index (“FT-
value accounting standards and not historical cost. REIT”). This index measures the performance of US REITs that
are listed on the New York Stock Exchange, the American Stock
The statistical issue with using the NPI and other benchmarks
Exchange or the NASDAQ.
like it is that they are based upon valuations that naturally
reference prior periods; consequently, they exhibit smoothed The Giliberto-Levy Commercial Mortgage Performance
performance. Due to this inherent characteristic of the data, Index (“G-Levy”) measures PrivD return and represents the
significant dependence across the periodic total returns over performance of institutional-grade commercial mortgage
time is present. The presence of this serial correlation means whole loans. Interestingly, serial correlation tests (not shown)
that the underlying asset values will react slowly to market found that this index did not exhibit smoothed performance.
changes. Thus, conventional risk measures (e.g., volatility) LisD performance is represented by the Bloomberg Barclays
that use these periodic returns will be understated and the Investment Grade US CMBS Index (“Barc CMBS”), which consists
resultant risk profile will not be comparable to listed market of investment-grade commercial mortgage-backed securities.
2
See for example Geltner et al (2003) and Lizeri et al (2012).
STEPSTONE | Blending the Real Estate Allocation 3FIGURE 2 | COMMERCIAL REAL ESTATE PERFORMANCE INDICES QUARTERLY SUMMARY STATISTICS AND CORRELATIONS
PrivEq PrivEq LisEq PrivD LisD
Statistic
NPI TBI FT-REIT G-Levy Barc-CMBS
Mean 0.024 0.024 0.031 0.017 0.016
Median 0.029 0.017 0.038 0.016 0.015
Maximum 0.054 0.178 0.333 0.085 0.123
Minimum (0.083) (0.172) (0.388) (0.076) (0.150)
Std. Dev. 0.02 0.05 0.10 0.02 0.04
Skewness (2.78) (0.30) (0.92) (0.44) (0.65)
Kurtosis 11.85 6.45 7.06 7.87 9.36
Jarque-Bera Statistic 350.88*** 39.29*** 63.75*** 78.47*** 135.43***
Correlation Matrix
NPI 1 — — — —
TBI 0.36 1 — — —
FT-REIT 0.22 0.25 1 — —
G-Levy 0.11 0.01 0.25 1 —
Barc-CMBS 0.10 0.19 0.58 0.72 1
*** indicates significance at the 1% probability level.
Source: FTSE, MSCI, NAREIT and NCREIF, Q2 2016; StepStone calculations.
For illustrative purposes only.
All analysis is undertaken using quarterly performance data their broader asset allocation decisions and adjust their
from the second quarter of 1997 through the second quarter models appropriately.
of 2016. REITs have historically delivered the highest level of volatility;
Summary statistics for these performance indices are provided however, these securities use financial leverage and are
in Figure 2, which shows that all the performance indices exposed to equity market price movements.3 Investors
generally have a low positive correlation with one another. will need to consider the trade-off between the additional
This suggests that while they all provide access to the US performance dispersion arising from this exposure against the
CRE market, they do so with specific performance patterns. enhanced levels of liquidity it provides.
The exception to this is the relationship between LisD and Statistical issues can also arise when focusing purely on mean-
PrivD, which have a high degree of positive correlation and variance based analysis, which continues to dominate much
delivered comparable levels of total returns to investors over of the commercial and academic research for CRE. A feature
the sample period. of financial market and private investment performance is
Using unsmoothed PrivEq performance series materially that the historical returns are often found to be non-normally
increases the level of reported volatility, with the estimated distributed. Given the inherent non-normality of private asset
TBI volatility being more than double that of the NPI, but classes such as PrivEq, however, performance volatility is
showing broadly the same level of historical total return. This not an ideal risk measure. Figure 3 shows a histogram with
finding highlights the degree of valuation smoothing that the distribution of the historical quarterly NPI performance
exists in valuation based performance indices such as the plotted against a normal distribution for this index’s historical
NPI. Investors should be mindful of this point when making mean and volatility.
3
An Appraisal of Real Estate Securities, Goldman Sachs Asset Management, March 2017.
4As can be seen in Figure 3, the historical NPI return distribution
differs materially from a normally distributed series, given FIGURE 3 | QUARTERLY NPI TOTAL RETURN—EMPIRICAL VS
its lack of symmetry from the equivalent normal distribution NORMAL DISTRIBUTION
plot in two key ways. First, it has a noticeable negative skew 25
with the distribution having a relatively long “tail” of negative
total returns. This implies a significant degree of downside risk 20
versus normally distributed asset class performance, although
Frequency
the bulk of these losses are attributable to the post-GFC period. 15
Second, the peak of the distribution is more pronounced.
10
The pronounced peak is not just an issue with PrivEq;
Figure 2 shows that all historical total returns series have a 5
kurtosis value above three.4 For the statistically minded, the
Jarque-Bera statistics also demonstrate that none of the series 0
(8) (7) (6) (5) (4) (3) (2) (1) 0 1 2 3 4 5 6 7 8
can be considered normally distributed.
Quarterly Total Return
This study simulates the historical performance of BRE
Empirical Normal Distribution Plot
portfolios composed of fixed capital allocations to market
Source: NCREIF, Q2 2016; StepStone calculations.
exposures representing the four quadrants of CRE.
Consequently, the analysis and results presented should be
considered as being very much strategic in nature. Risk-return
metrics are estimated for BRE portfolios using both smoothed
and unsmoothed PrivEq return performance. The five portfolio
strategies used and their capital allocations are as follows:
» PrivEq only (“Private Equity”);
FIGURE 4 | BLENDED REAL ESTATE PORTFOLIO STRATEGIES
» Equally weighted PrivEq and PrivD (“Equal Weight Private”);
CORRELATION WITH S&P 500
» Equally weighted quadrants (“Equal Weight Quadrant”);
0.6
» A DC plan equity real estate portfolio consisting of an 80:20
PrivEq/LisEq split (“DC Equity”). This is consistent with several 0.5
Correlation with S&P 500
available products targeted at the DC plan market such as
0.4
the Principal Real Estate Equity Income Strategy (85% target
PrivEq allocation) for the US; and 0.3
» A DC plan equity real estate portfolio consisting of 40%
0.2
PrivEq, 40% PrivD, 10% LisEq and 10% LisD (“DC Quadrant”).
The historical performance and risk metrics for these portfolio 0.1
strategies, incorporating either smoothed or unsmoothed
0.0
performance, as presented by the NPI and TBI respectively, are Private Equal Equal DC - DC -
Equity Weight - Weight - Equity Quadrant
shown in Exhibit A in the Appendix. Private Quadrant
As highlighted in Figure 4, the correlations with the Smoothed PMEq Unsmoothed PMEq
general equity market, as represented by the S&P 500, do
not materially change when using either the NPI or the TBI. Source: FTSE, MSCI, NAREIT; NCREIF, Q2 2016; StepStone calculations.
4
A value of three signifies a normal probability distribution. When a distribution has a kurtosis value above three, then it is leptokurtic and is characterized as
being more “peaked” with fatter tails thereby indicating the presence of extreme outcomes.
STEPSTONE | Blending the Real Estate Allocation 5For the PrivEq performance: the correlation statistics are 0.21
and 0.18 respectively. Including debt exposure dilutes the FIGURE 5 | BLENDED REAL ESTATE PORTFOLIO STRATEGIES
level of absolute return delivered in a private markets real MODIFIED SHARPE RATIOS
estate program, but enhances risk-adjusted returns. Figure
0.4
4 also shows that its inclusion delivers modest diversification
benefits relative to general equities. These benefits, however
are naturally offset by a higher correlation with broader bond 0.3
Modified Sharpe Ratio
markets. For DC plan investors, the public equity exposure
increases the level of volatility from 4.8% to 6.2% on an 0.2
annualized basis when using the NPI. When using the TBI,
however, volatility is practically unchanged and investors also
benefit from an improved liquidity profile. Finally, as per the 0.1
individual performance indices, all these portfolio strategies
can be considered as having non-normal performance 0.0
characteristics as inferred by their skewness, kurtosis statistics Private Equal Equal DC - DC -
Equity Weight - Weight - Equity Quadrant
and highly significant Jarque-Bera test results. Private Quadrant
Smoothed PMEq Unsmoothed PMEq
Risks and Returns of Commercial Real Source: FTSE, MSCI, NAREIT and NCREIF, Q2 2016; StepStone calculations.
Estate Allocations
Most published and commercial research relating to CRE in be exposed to extreme downside outcomes than investors
an asset allocation context still uses volatility as the central with shorter-term hold periods. These outcomes can impair
measure of risk. Clearly, given the non-normality of CRE the achievement of long-term target return levels. CVaR is
performance series used in this study, this measure is not calculated using the modified CVaR estimator from Boudt et
ideal. One of the aims of this study is to analyze portfolio risk al (2008), which is found to better account for portfolios with
characteristics using a measure that better accounts for both non-normal performance characteristics.
downside risk and the performance characteristics of asset
classes such as CRE. BLENDED REAL ESTATE PORTFOLIO STRATEGIES
To do this we use conditional value at risk (“CVaR”). CVaR Exhibit B in the Appendix details the risk attribution for
only measures risk in downside-risk terms and can capture the portfolio strategies described above. This provides the
the non-normal characteristics of the data. To provide clarity estimated risk contribution for each individual quadrant
on the risk allocations to various exposures, we use the CVaR within the BRE portfolios. Results are presented using both
risk budgeting framework of Boudt et al (2013). Portfolio smoothed and unsmoothed PrivEq performance, as well as for
risk budgeting involves attributing the contribution to total both volatility and CVaR. Naturally the use of the TBI results
portfolio risk of each component asset class or investment in PrivEq comprising a greater share of the estimated risk
position. Whereas volatility based risk budgeting is relatively profile of the portfolios. Using the unsmoothed PrivEq data
common, downside risk based frameworks are much less series, the inclusion of the additional quadrants improves risk-
prevalent. However, given the “left-tail” performance adjusted portfolio performance when focusing on volatility.
characteristics of the historical return series used in this study, The results are more mixed when using the CVaR metric. This
we believe that institutional investors and asset allocators is highlighted further in Figure 5 that shows the Modified
should be more focused on this aspect of risk. This is especially Sharpe ratios for the simulated real estate portfolio strategies.
true for long-term investors who are able accept the relative For DC investors, including a more liquid exposure does not
illiquidity of private asset classes and thus are more likely materially impair risk and return, with the DC-Equity portfolio
6providing robust risk-adjusted performance. Noticeably, portfolio strategies offer the most limited diversification
PrivD enhances risk-adjusted returns, albeit at the expense of benefits generally. At a 10% allocation level, all BRE strategies
absolute performance. lower risk both in terms of volatility and CVaR. The use of
unsmoothed private equity performance clearly increases
COMMERCIAL REAL ESTATE IN A MULTI-ASSET CONTEXT estimated portfolio risk and the contribution of BRE exposures
To provide insight into the risk contribution of CRE to to overall portfolio risk. The non-normal characteristics of CRE
traditional multi-asset portfolios, we use the five portfolio investment performance discussed earlier also lead to the BRE
strategies and incorporate them into multi-asset portfolios, strategies contributing a greater share of overall portfolio risk.
composed of the “traditional” 60:40 allocation to equities Interestingly, the use of BRE portfolios incorporating both
and bonds. The equity market is represented by the S&P 500 PrivEq and PrivD exposures does not dilute overall portfolio
Index and bonds by the Bloomberg Barclays US Aggregate performance but does provide diversification benefits and
Bond Index. Our central results assume a 10% allocation enhance risk-adjusted returns. When looking at the Equal-
to real estate, which is based on the 2016 Institutional Real Weight Private portfolio strategy there is a modest reduction
Estate Allocations Monitor produced by Cornell University in both estimated portfolio volatility and CVaR, but at a
and Hodes Weill & Associates.5 This found that the average 10% allocation it delivers the lowest CVaR metric of all
institutional investor target allocation for real estate was portfolios presented.
9.9% and that this was trending upwards. To provide further
context on the multi-asset benefits of real estate, analysis for
a 20% target allocation is also presented. The results of this Conclusions
analysis are presented in Exhibit C and uses both volatility
and CVaR as metrics that are contrasted. All CVaR statistics are COMMERCIAL REAL ESTATE IS AN ATTRACTIVE
presented on a quarterly basis and assume a five percent loss ASSET CLASS
probability. The Modified Sharpe Ratio is calculated using the
StepStone believes that CRE should be a component of all
estimated quarterly CVaR as the denominator.
institutional investor portfolios. It can be accessed through
The results in Exhibit C also show that all real estate portfolio
several investment formats, each of which has unique risk and
strategies are accretive to the risk-adjusted performance of a
return characteristics.
traditional 60:40 portfolio. Over the sample time-period, the
general US equity exposure is the significant contributor to
overall portfolio risk and its share increases when considering BE MINDFUL OF STATISTICAL CONSIDERATIONS
it within a downside risk framework. When using volatility as Our analysis suggests that investors should be mindful of
a risk measure the inclusion of a 10% or 20% BRE exposure the statistical issues associated with CRE and other private
reduces overall portfolio risk irrespective of which of the five markets asset class performance measures—such as valuation
BRE strategies is selected. This result holds irrespective of smoothing—when making their asset allocation decisions.
whether the PrivEq exposure is modelled on a smoothed or We would also advise investors against focusing extensively
unsmoothed basis. on mean variance based analysis. Given the non-normal
However, the non-normal performance characteristics are performance characteristics shown, asset allocation and risk-
evident in the risk contribution to the portfolios shown when frameworks should address the “left-tail“ downside risks seen.
using CVaR. Indeed, the 20% BRE exposure incrementally adds This is particularly true for longer-term institutional investors
to risk for the DC Equity and Equal Weight Quadrant strategies, in illiquid asset classes such as PrivEq who are likelier to be
irrespective of the PrivEq performance index chosen. These exposed to extreme downside outcomes.
5
Please see http://www.hodesweill.com/research/allocations-monitor/.
STEPSTONE | Blending the Real Estate Allocation 7CONSIDER RISK CONTRIBUTIONS WHEN MAKING CONSIDER EXPOSURE TO PRIVATE DEBT
ALLOCATION DECISIONS The results show that PrivD can be a particularly beneficial
Investors should also be more thoughtful of the contribution exposure from a risk-return standpoint. While the analysis
to risk from various asset classes and not be solely focused on presented in this study is intended to be strategic in nature,
StepStone believes there is a compelling tactical case for
capital allocations. This study demonstrated that for a range
including PrivD in institutional investor portfolios. Globally,
of BRE portfolio strategies tailored to investor preferences risk
the prospective performance of Core equity opportunities in
allocations often differed markedly to their capital allocations.
major markets has, in our view, moderated to below average
levels of expected total returns. At this point in the real estate
A TYPICAL BLENDED REAL ESTATE ALLOCATION market cycle, StepStone would recommend that clients
IS ACCRETIVE consider adding PrivD. We are of the view that private US and
European real estate Core-Plus debt exposures though whole
A range of BRE portfolio strategies were shown to be accretive
loan, stretch senior and mezzanine debt investments backed
to overall risk-adjusted portfolio performance when included
against institutional quality CRE assets and at moderate loan-
at a typical institutional investor allocation level of 10%.
to-value ratios can add attractive blended returns of mid to
This benefit is also evident at a higher allocation level when
high single digits. Given the downside protection afforded
focusing on the volatility risk measure, which may not be and the majority paid income component of these exposures,
ideal given the performance characteristics of the asset class. we believe that this represents an attractive risk-adjusted
The equivalent results using the CVaR risk measure were less return and should be considered by institutional investors
conclusive when making a 20% allocation to a BRE exposure. both strategically and more tactically.
8Appendix
Exhibit A | BLENDED REAL ESTATE PORTFOLIO STRATEGIES
Smoothed PrivEq Performance
Private Equal Weight - Equal Weight - DC - DC -
Equity Private Quadrant Equity Quadrant
Mean 0.024 0.020 0.022 0.025 0.021
Median 0.029 0.022 0.025 0.029 0.025
Maximum 0.054 0.052 0.113 0.072 0.052
Minimum (0.083) (0.079) (0.174) (0.144) (0.117)
Std. Dev. 0.024 0.017 0.036 0.031 0.022
Skewness (2.784) (2.997) (2.200) (3.460) (3.696)
Kurtosis 11.852 18.708 13.834 18.981 23.118
Jarque-Bera Statistic 350.88*** 906.91*** 438.68*** 972.96*** 1473.81***
Annualized Sharpe Ratio 1.62 1.86 0.93 1.31 1.47
Correlation With S&P 500 0.21 0.07 0.50 0.52 0.37
Correlation With All Bonds (0.10) 0.27 0.17 (0.06) 0.23
Unsmoothed PrivEq Performance
Private Equal Weight - Equal Weight - DC - DC -
Equity Private Quadrant Equity Quadrant
Mean 0.024 0.020 0.022 0.025 0.021
Median 0.017 0.017 0.025 0.029 0.021
Maximum 0.178 0.089 0.115 0.140 0.090
Minimum (0.172) (0.070) (0.155) (0.201) (0.089)
Std. Dev. 0.049 0.027 0.039 0.049 0.029
Skewness (0.295) (0.033) (1.410) (1.207) (1.051)
Kurtosis 6.449 4.499 8.807 7.869 6.484
Jarque-Bera Statistic 39.29*** 7.22** 133.70*** 94.76*** 53.12***
Annualized Sharpe Ratio 0.76 1.14 0.85 0.82 1.09
Correlation With S&P 500 0.18 0.11 0.49 0.39 0.33
Correlation With All Bonds 0.05 0.25 0.18 0.04 0.24
*** indicates significance at the 1% probability level, ** indicates significance at the 5% probability level.
Source: FTSE, MSCI, NAREIT and NCREIF, Q2 2016; StepStone calculations.
For illustrative purposes only.
STEPSTONE | Blending the Real Estate Allocation 9Exhibit B | W
EIGHT AND RISK ALLOCATIONS OF BLENDED REAL ESTATE PORTFOLIO STRATEGIES. IN-SAMPLE MEAN, VOLATILITY AND QUARTERLY MODIFIED 95% CVaR
Smoothed Private Real Estate Equity Performance
Risk-Adjusted
Real Estate Portfolio Weighting % Standard Deviation Allocation % Modified CVaR Allocation % Performance
Equity Debt Ann Ann Equity Debt 95% Equity Debt Annualized Modified
Mean SD Modified Sharpe Ratio Sharpe Ratio
Private Public Private Public % % Private Public Private Public CVaR Private Public Private Public
Private Equity 100 — — — 9.6 4.7 100 — — — 5.6 100 — — — 1.62 0.34
Equal Weight -
50 — 50 — 8.2 3.3 55.2 — 44.8 — 6.0 29.7 — 70.3 — 1.86 0.36
Private
Equal Weight -
25 25 25 25 8.7 7.2 5.8 67.4 7.5 19.3 14.2 9.0 55.6 10.2 25.2 0.93 0.12
Quadrant
DC - Equity 80 20 — — 10.1 6.2 45.7 54.3 — — 10.7 37.4 62.6 — — 1.31 0.19
DC - Quadrant 40 10 40 10 8.4 4.3 25.5 36.5 25.7 12.3 8.1 1.9 43.1 37.5 17.5 1.47 0.20
Unsmoothed Private Real Estate Equity Performance
Risk-Adjusted
Real Estate Portfolio Weighting % Standard Deviation Allocation % Modified CVaR Allocation % Performance
Equity Debt Ann Ann Equity Debt 95% Equity Debt Annualized Modified
Mean SD Modified Sharpe Ratio Sharpe Ratio
Private Public Private Public % % Private Public Private Public CVaR Private Public Private Public
Private Equity 100 — — — 9.5 9.9 100 — — — 11.1 100 — — — 0.76 0.17
Equal Weight -
50 — 50 — 8.2 5.4 84.6 — 15.4 — 6.8 69.3 — 30.7 — 1.15 0.22
Private
Equal Weight -
25 25 25 25 8.8 8.2 14.9 56.5 6.4 22.1 15.9 16.7 45.6 10.9 26.8 0.83 0.11
Quadrant
DC - Equity 80 20 — — 10.1 9.8 73.4 26.6 — — 11.1 43.4 56.6 — — 0.82 0.18
DC - Quadrant 40 10 40 10 8.4 5.9 52.0 23.7 14.0 10.2 10.9 18.9 35.3 27.4 18.4 1.09 0.15
Source: FTSE, MSCI, NAREIT and NCREIF, Q2 2016; StepStone calculations.
For illustrative purposes only.
10Exhibit C | WEIGHT AND RISK ALLOCATIONS OF 60:40 EQUITY : BOND PORTFOLIOS INCLUDING COMMERCIAL REAL ESTATE. IN-SAMPLE MEAN, VOLATILITY AND
QUARTERLY MODIFIED 95% CVaR
Smoothed Private Real Estate Equity Performance
Risk-Adjusted
Multi-Asset Portfolio Weighting % Standard Deviation Allocation % Modified CVaR Allocation % Performance
Ann Ann SD 95% Annualized Modified
Private Real Equal Weight - Equal Weight - DC - DC - Real Real
Equities Bonds Modified Sharpe Sharpe
Equity Bonds Estate Equity Private Quadrant Equity Quadrant Mean % % Estate Equities Bonds Estate
CVaR Ratio Ratio
60 40 — — — — — 7.5 9.8 103.2 (3.2) 8.7 116.5 (16.5) — 0.55 0.16
54 36 10 — — — — 7.7 8.9 101.9 (3.2) 1.3 8.1 112.7 (15.7) 3.0 0.63 0.18
54 36 — 10 — — — 7.5 8.9 102.5 (3.1) 0.5 7.9 115.0 (16.3) 1.3 0.62 0.17
54 36 — — 10 — — 7.6 9.3 98.1 (2.8) 4.7 8.5 107.1 (15.1) 8.1 0.60 0.16
54 36 — — — 10 — 7.7 9.2 99.2 (3.1) 3.9 8.4 107.9 (14.9) 7.0 0.62 0.17
54 36 — — — — 10 7.6 9.0 100.8 (3.0) 2.2 8.1 111.8 (15.8) 4.0 0.61 0.17
48 32 20 — — — — 7.9 8.1 99.6 (3.2) 3.6 8.3 107.2 (14.7) 7.5 0.73 0.18
48 32 — 20 — — — 7.6 8.0 101.3 (2.9) 1.6 8.1 111.4 (15.9) 4.6 0.70 0.17
48 32 — — 20 — — 7.7 8.7 91.4 (2.3) 10.9 9.2 95.1 (13.8) 18.6 0.65 0.15
48 32 — — — 20 — 8.0 8.6 93.7 (2.8) 9.1 9.0 97.8 (13.3) 15.5 0.70 0.17
48 32 — — — — 20 7.7 8.3 97.4 (2.6) 5.2 8.5 104.7 (15.0) 10.3 0.68 0.17
Smoothed Private Real Estate Equity Performance
Risk-Adjusted
Multi-Asset Portfolio Weighting % Standard Deviation Allocation % Modified CVaR Allocation % Performance
Ann Ann SD 95% Annualized Modified
Private Real Equal Weight - Equal Weight - DC - DC - Real Real
Equities Bonds Modified Sharpe Sharpe
Equity Bonds Estate Equity Private Quadrant Equity Quadrant Mean % % Estate Equities Bonds Estate
CVaR Ratio Ratio
60 40 — — — — — 7.5 9.8 103.2 (3.2) — 8.7 116.5 (16.5) — 0.55 0.16
54 36 10 — — — — 7.7 9.1 99.8 (3.0) 3.2 8.1 110.4 (14.5) 4.1 0.62 0.17
54 36 — 10 — — — 7.5 8.9 101.7 (3.0) 1.3 7.9 114.7 (15.8) 1.1 0.62 0.17
54 36 — — 10 — — 7.6 9.3 97.7 (2.7) 5.0 8.4 107.2 (14.9) 7.8 0.60 0.17
54 36 — — — 10 — 7.7 9.3 97.6 (2.9) 5.2 8.4 106.8 (14.1) 7.3 0.61 0.17
54 36 — — — — 10 7.6 9.1 100.1 (2.9) 2.7 8.1 111.8 (15.4) 3.7 0.61 0.17
48 32 20 — — — — 7.9 8.5 93.1 (2.6) 9.5 8.5 100.4 (14.9) 11.5 0.69 0.17
48 32 — 20 — — — 7.6 8.1 98.9 (2.6) 3.7 8.0 111.1 (14.9) 3.7 0.69 0.17
48 32 — — 20 — — 7.7 8.8 90.5 (2.2) 11.7 9.2 95.9 (13.4) 17.5 0.65 0.16
48 32 — — — 20 — 8.0 8.8 89.5 (2.4) 13.0 9.1 95.0 (11.6) 16.6 0.67 0.16
48 32 — — — — 20 7.7 8.4 95.6 (2.4) 6.8 8.5 105.2 (14.3) 9.1 0.67 0.17
Source: FTSE, MSCI, NAREIT and NCREIF, Q2 2016; StepStone calculations.
For illustrative purposes only.
11
STEPSTONE | Blending the Real Estate AllocationReferences Kurtosis
Boudt K., Carl P. and Peterson B. (2013). Asset allocation with
Kurtosis measures whether the data are heavy-tailed or light-
Conditional Value-at-Risk budgets. Journal of Risk, 15, 39-68.
tailed relative to a normal distribution. It is calculated using
Boudt, K., Peterson, B. and Croux, C. (2008) Estimation and the following formula:
decomposition of downside risk for portfolios with non-
normal returns. Journal of Risk, 11, 79-103.
Fisher, J. Geltner, D. & Pollakowski, H. (2007). A quarterly
Kurt(X) = ∑[(X−σ )4]μ
transactions-based index (TBI) of institutional real estate
investment performance and movements in supply and Where: X= the sample series, μ = the sample mean and σ = the
demand. Journal of Real Estate Finance & Economics, 34, 1, 5-33. sample standard deviation.
Geltner, D., MacGregor, B. D. & Schwann, G. M. (2003). Kurtosis for a normal distribution is zero. Security or portfolio
Appraisal smoothing & price discovery in real estate markets. return distributions with high or excess kurtosis (>3) have
Urban Studies, 40, 1047-1064. “heavy“ tails with outliers and those with low kurtosis (Value at Risk (“VaR”) Sharpe Ratio
VaR is a risk measure that is used to estimate the potential A measure of risk-adjusted return which measures the average
investor loss on a security or portfolio at a given confidence return of a security or portfolio, earned in excess of the risk-
interval over a given period. It provides an estimated free rate per unit of volatility or total risk. It is calculated by
“breakpoint“ in security or portfolio returns under extreme subtracting the risk-free rate from the mean return, and
conditions. Normal VaR is calculated using the first two dividing this by the level of volatility over the same period. The
statistical moments of the reference security or portfolio greater the value of a Sharpe Ratio then the more attractive a
return distribution, namely the mean and standard deviation. security or portfolio is on a risk-adjusted basis.
This can be calculated using the following formula:
V aR = μ + σC
Modified Sharpe Ratio
Where: μ= the sample mean, σ = the sample standard deviation A measure of risk-adjusted return which measures the average
and C is an assumed confidence level. return of a security or portfolio, earned in excess of the risk-free
rate per unit of total risk. The Modified Sharpe ratio is a version
of the original Sharpe ratio amended to include non-normal
data. In this study, it is calculated by subtracting the risk-free
Conditional Value at Risk (“CVaR”) rate from the mean return, and dividing this by the CVaR over
CVaR is a risk measure that shows the expected return on the same period. The greater the value of a Modified Sharpe
security or portfolio in an assumed percentage of extreme Ratio then the more attractive a security or portfolio is on a
cases beyond a VaR “breakpoint.“ It is calculated by taking the risk-adjusted basis.
average total returns beyond the assumed VaR breakpoint.
This is estimated using the following formula:
CV aR(a) = −E (R ≤ −V aR (a))
Where: R= is the average return below the VaR breakpoint and
α is an assumed percentage level.
STEPSTONE | Blending the Real Estate Allocation 13This document is for information purposes only and has been compiled with publicly available information. StepStone makes no guarantees of the accuracy of the information provided. This information is for the use of StepStone’s clients and contacts only. This report is only provided for informational purposes. This report may include information that is based, in part or in full, on assumptions, models and/or other analysis (not all of which may be described herein). StepStone makes no representation or warranty as to the reasonableness of such assumptions, models or analysis or the conclusions drawn. Any opinions expressed herein are current opinions as of the date hereof and are subject to change at any time. StepStone is not intending to provide investment, tax or other advice to you or any other party, and no information in this document is to be relied upon for the purpose of making or communicating investments or other decisions. Neither the information nor any opinion expressed in this report constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. Past performance is not a guarantee of future results. Actual results may vary. Each of StepStone Group LP, StepStone Group Real Assets LP and StepStone Group Real Estate LP is an investment adviser registered with the Securities and Exchange Commission (“SEC”). StepStone Group Europe LLP is authorized and regulated by the Financial Conduct Authority, firm reference number 551580. Swiss Capital Invest Holding (Dublin) Ltd (“SCHIDL”) is an SEC Registered Investment Advisor and Swiss Capital Alternative Investments AG (“SCAI”) (together with SCHIDL, “Swiss Cap”) is registered as a Relying Advisor with the SEC. Such registrations do not imply a certain level of skill or training and no inference to the contrary should be made. Manager references herein are for illustrative purposes only and do not constitute investment recommendations. 14
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