External managers increase costs and underperform for pension funds that use them to invest in real estate, Mastricht University research has found.
The study of 884 European, US, Canadian, Australian and New Zealand pension funds from 1990 to 2009 found that, even controlling for fund size and costs, switching from internal to completely external management reduced returns by 102bps on average.
Investing in funds-of-funds cut returns even more, by 202bps. “On average, both public and private real estate portfolio managers do not exhibit market timing or security selection skills,” the report says.
The study found larger funds obtain higher returns on direct and REIT investments – even taking into account economies of scale in costs and approach to managing internally or externally.
“Larger funds apparently have better skills, enabling them to select better properties when investing internally and better money managers when investing externally,” the report says.
“When investing externally, larger funds are likely to get preferential treatment, have greater monitoring capacity and may access better investment opportunities at lower cost.”
Larger funds were more likely to invest in listed REITs, even though arguably these vehicles provide the sort of liquid and scalable real estate exposure that should attract smaller pension funds. REITs delivered a higher return on average, at 10.9%, against direct real estate’s 6.7%.
But real estate funds’ 76bps average investment costs (minus performance fees) are far lower than for private equity (700bps) and hedge funds (426bps). European pension funds have the lowest property investment costs: an average 38bps, against 91bps for the US.