Listed real estate investments in the Government Pension Fund Global
Norges Bank's letter to the Ministry of Finance of 14 March 2013
In its letter of 25 January 2013, the Ministry of Finance asked Norges Bank to analyse a number of questions concerning the characteristics of investments in listed real estate companies and funds relative to investments in the broad stock market.
Listed real estate stocks’ share of the benchmark index
Real estate stocks form part of the FTSE industry group Financials and are divided into two sectors: Real Estate Investment & Services and Real Estate Investment Trusts (REITs). At the end of January 2013, these two sectors made up 3.5 percent of the benchmark index for equity investments as defined in the mandate for the management of the Fund. REITs accounted for around 2 percent of the benchmark index.
The real estate sector’s share of the stock market has grown over the past decade and is slightly higher in the FTSE All Cap index than in the FTSE All-World index, which indicates that the sector accounts for a larger share of the small-cap segment.
Listed real estate stocks account for 3.5 percent of the Fund’s strategic benchmark index for equity investments.
Return variation in the real estate sector
Short-term variation in the return on listed real estate stocks can be explained largely by variation in the return on the broad stock market.
We have analysed the return on listed real estate stocks using our own factor model for the period from June 2002 to December 2012 and find that 60.3 percent of daily return variation can be explained by daily return variation in the broad stock market. The explanatory power increases to 64.4 percent when the analysis is extended to include the size and value factors. We find that the sector has had a positive sensitivity to the size and value factors.
We obtain similar results when we analyse the return on US REITs using factors from Kenneth French’s data library for the US stock market. This analysis covers the period from January 2001 to December 2012. We find that 54.9 percent of daily variation in the return on US REITs can be explained by daily return variation in the US stock market. The explanatory power increases to 67.8 percent when the analysis is extended to include the size and value factors. We find that the sector has had a positive sensitivity to the size and value factors.
The relationship between the return on listed real estate stocks and the broad stock market is not stable. When we consider the real estate sector’s sensitivity to variation in the market based on observations over one-year rolling windows, we find that it has ranged between a high of 1.48 in February 1995 and a low of 0.24 in January 2001. Nor is the real estate sector’s sensitivity to the size and value effects stable.
Our analysis ties in with academic studies which find that listed real estate stocks are exposed to the size and value effects and that exposure to these factors varies over time (see, for example, Liu, Crocker and Mei (1992), Chiang and Lee (2002), and Clayton and MacKinnon (2001)).
Short-term variation in the return on listed real estate stocks can be explained largely by variation in the return on the broad stock market.
The real estate sector’s risk and return characteristics relative to other sectors
We have calculated relevant financial ratios for all sectors of the FTSE All Cap. These show that the fundamental characteristics of the listed real estate sector do not differ from the broad market any more than those of other sectors.
We have also assessed the relationship between return and risk in different sectors over the past 20 years. In each sector, this relationship is critically dependent on the period covered by the analysis. If we rank sectors by the relationship between return and risk in the first ten-year period, this bears no relationship to the ranking for the subsequent ten-year period. The real estate sector does not differ from the broad market in a way that is systematically different to other sectors.
One key feature of the market is that all sectors’ correlation with the broad market has increased.
The real estate sector’s risk and return characteristics do not differ from the broad stock market in a way that is systematically different to other sectors.
Yours faithfully
Vegard Vik Lise Lindbäck