Benchmarking Other Alternative Investments
There's an old saying in real estate that the three most important things to consider are location, location, and location.
What does that suggest for benchmarking a real estate portfolio?
Exactly.
Real estate professionals are always trying to find "comps," or comparable properties for a single property valuation, but this one is a little closer to the highway, facing that direction, and with a unique view. They are all just different properties.
Not really. The idea of the saying is that a specific location is extremely important. A nationwide average won't capture what's happening to a specific property.
Not really. The idea of the saying is that a specific location is extremely important. Comparing to other local properties is just a start.
Of course, plenty of real estate indexes exist. You can find them in nearly every country, with some based on property type, investment style, and other considerations. But these obviously have to be based on samples only. Also, many are made from numbers that real estate managers report. How might that bias the returns?
Very likely, yes.
Unlikely. Managers like to report good numbers, so there's more likely to be an upward bias.
Appraisals are infrequent, so there's a lag in valuation changes. Some are leveraged and others not. Some use time-weighted returns and others use internal rates of return. So by all means use a benchmark or two if you're getting into real estate, but think of all the considerations involved both in choosing one, and in the construction of the benchmarks themselves.
How do you think this compares to benchmarks of private equity?
That's true. There aren't as many, but there is still the question of lagged valuations, since they don't really know until exit. The valuation methodologies vary here as well, and returns are likely to be self-reported. One small difference here is that IRRs are predominantly used, and geography is less of a problem; even though peer group indexes are separated based on geography and other subclasses.
It really isn't.
No, it can. And it does.
Commodities are different. What's one big contrast between commodities and real estate or private equity?
No, they do. Buy some and see.
Right. All real estate properties are different, and each private equity deal is different. But gold is gold wherever you go. The price bounces around a lot, as do the prices of cotton, oil, and soybeans. So commodity traders need some sort of index to measure performance as well.
Not at all. Silver traded at over USD 40 per ounce in 2011 and under USD 15 a few years later.
How would a fund manager take a long commodities position, such as in crude oil?
That's not it; you won't find a portfolio manager with 100 barrels of oil in the office.
Exactly. Futures contracts are nearly always used for commodities positions, and so indexes are made from futures price changes as well, such as the Goldman Sachs Commodity Index (GSCI) and others. They try to show returns of holding long positions.
Unlikely; options contracts wouldn't get you the same profit profile of a long position in oil itself.
Would you consider the GSCI an investable index?
You're right!
Actually, it is.
The index is basically a set of futures contracts, which can also be purchased by others. But as with most asset classes, there's still the question of which index is appropriate, since they vary greatly in the type of commodities represented and the weightings on those commodity subtypes.
Finally, there are a couple of alternative asset classes that just don't have decent market indexes at all; just a few peer group indexes chosen by strategy. This is the case for managed derivatives and distressed securities. What bias will you find with a peer group index?
In hindsight, you'll realize that it is actually survivorship bias.
You got it!
That can't be confirmed, no; it's survivorship bias.
In order to be part of a current peer group, you of course have to still be in business. The managers of managed derivatives funds and distressed securities funds are those who have survived to date, and not those who have failed. So there will be an upward bias in any peer group index for this reason.
To summarize:
[[summary]]
It's very difficult
It should be based on nationwide values
It's straightforward if you compare to local properties
Upward
Downward
There are many similar features
Private equity is more transparent
Private equity can't have benchmarks
Specific commodities are the same everywhere
Commodities don't offer returns
Commodity returns have historically been very stable
By buying physical oil
By buying futures contracts
By buying options contracts
Yes
No
Survivorship bias
Hindsight bias
Confirmation bias
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