Many financial advisors and RIAs adhere to the asset allocation model pioneered by David Swensen, who managed the Yale endowment. During Swensen’s hugely successful tenure at Yale, he emphasized diversification into non-correlated assets and a long-term, low-fee approach to investing.
Swensen invested directly into private real estate because he believed these were the only investments that could provide true, non-correlated, inflation protected diversification under his asset allocation model, and that they offered higher returns than public markets.
Historically, Private Real Estate is Not Correlated to Public Equities
Swensen believed that since REITs and REIT ETFs are publicly traded securities, they were far too correlated to public equities, and as a result they could not provide the diversification he sought. Accordingly, Swensen avoided them because the Yale endowment already had exposure to public equities, and under his asset allocation model, he believed that private real estate investments could provide a much higher level of diversification and inflation protection than publicly traded REITs and REIT ETFs.
“A historic benefit of [private real estate funds] is their returns are less volatile than REITs“Bloomberg, January 17, 2023
Nevertheless, even though many financial advisors and RIAs adhere to Swenson’s asset allocation model, some advisors claim they cannot possibly replicate the results achieved by David Swenson at Yale because their AUM is a fraction of Yale’s AUM, and as a result they cannot gain access to the best institutional managers with the most advantageous fee structures. Consequently, these advisors are still filling their alternative investment buckets with REITs and REIT ETFs.
Historically, it was true that the first generation of private market alternatives were generally available only to Qualified Purchasers, which are individuals or entities with $5 million or more of investable assets. However, the alternatives market has expanded considerably since then, and there are now numerous institutional-quality managers serving the wealth management marketplace with high quality offerings and lower minimums.
The Best Real Estate Managers Are Not Always the Largest Firms
There are still “Best in Class” institutional managers who continue to maintain investment minimums of $5 million or more, and advisors with smaller portfolios cannot get allocations to these managers. More important, if advisors are unable to commit to higher minimums, they are often unable to negotiate the more favorable fee structures that can be obtained by larger investors. Consequently, many smaller advisors who cannot commit to higher minimums still turn to REITs as a substitute for private real estate , even though REITs and REIT ETFs are highly correlated to the broader stock market.
We believe these advisors should not throw in the towel on private real estate investments so quickly, because private markets, in addition to being less correlated to public markets, can also offer higher returns. One of our long-term investment partners is the CEO of an NYSE listed investment firm with $1.5 trillion in actively-managed AUM. This person can easily meet the minimums required by larger institutional managers, but she also believes she can achieve more attractive risk-adjusted returns by taking the time to identify smaller, high-quality managers who are just as thoughtful about risk, fees, waterfall structures, and alignment of interests as larger, more well-known managers.
Liquidity Can Be Costly
Data shows that private markers (private credit, private real estate, and private equity) have historically offered premium returns relative to seemingly less expensive alternatives like REITs and REIT ETFs, and these higher returns can obviously be of great value when it comes to helping investors meet their long term objectives.
Franklin Templeton, an investment manager with $1.4 trillion in assets under management refers to this as an “illiquidity premium.” In a recent research report entitled “The Cost of Being Too Liquid,” Franklin Templeton says that while the magnitude of the illiquidity premium will vary over time, depending upon the market environment and the fund, the data show that private equity, private credit and private real estate have historically delivered a substantial illiquidity premium relative to their public market equivalents. You can download the research report here.
Obtain True Non-Correlated Real Estate Exposure Without Sacrifice
By taking the time to identify and establish relationships with smaller, high-quality managers, we believe that smaller advisors and RIAs can still obtain above market returns through true, non-correlated exposure to real estate under Swensen’s asset allocation model without sacrifice. [RELATED UPDATE: Calpers Makes $1 Billion Bet on Small Funds.]
If you are an Registered Investment Advisor considering direct investments, please ask us about the Depository Trust Company’s AIP product, which was designed specifically for RIAs. Piping Rock joined DTC’s AIP platform because it allows advisors to maintain custody of private real estate assets within their existing clearing, custody and settlement platforms, including Pershing, Schwab and Fidelity. This means that investing in private real estate will not affect your AUM and that your monthly client statements will remain fully integrated and complete.