Whilst there is little evidence of valuable forecasting ability in the direct real estate markets*, it is commonplace for investment managers to spend a great deal of time forecasting rents, yields and total returns, as represented by valuation-based indices. These forecasts are then combined with top-down calls regarding funds’ weights, which, despite the claim of forecasting ability, can result in low active share** funds (if active share is measured as the average absolute deviation from the index’s segment weights).

I have not come across any research into this, but, I suspect that the forecasts that are produced for each segment are not often statistically significantly different from one another. If you had produced the forecasts, the associated fan charts, which visually demonstrate the uncertainty around them, would probably just be too scary to confront and, people might notice, without any statistics, that the predictions are not the kind of thing you would want to take action upon.

Nonetheless, fund managers then get busy trying to match these target weights in the hope and expectation that:

1. the forecasts are correct, at least in ranking the segments

2. the properties that they choose to buy perform better than the segment they are in, and the properties that they choose to sell perform worse than the segment they are in, net of the transaction costs that are necessary to make the change, and, the impact of valuation uncertainty on the price that is achieved (usually insured against by the mantra of selling above valuation - i.e. potentially selling the best quality assets in the segment that is forecast to underperform)

3. others will buy the assets (at or above valuation of course) which they are selling (even though the market knows the vendor expects the segment they are in to underperform and that they need to sell to satisfy off-index weightings) and, that they will be able to buy assets at prices which reflect the valuation-based index, upon which the forecasts were based (from sellers who know that the purchaser needs to buy them to satisfy off-index weights).

There are probably more assumptions than this but that feels like enough to be going on with.

This is a constantly moving feast, and may all seem a bit suspect, but, regardless of that, the behaviour is there and the resulting turnover is easily taxed. Now, normally, the idea of forced selling is predicated by some type of liquidity event, but, the process described here also results in forced sales and purchases to satisfy the off-index weights, just as an equities fund which tracks an equities index is a forced purchaser and seller to ensure that its weights are the same as those in the index.

The Investment Property Forum (IPF) survey of UK investment managers’ forecasts*** gives us a good idea of what will be being sold and what will be being bought and, currently, with logistics forecast to outperform and retail to underperform, this amounts to an implied “buy logistics, sell retail”, or perhaps even, “buy good logistics and sell weak retail”.

Accordingly, some are going to think it is a good idea to do the opposite.

* See for example IPF (2012) “Re-assessing the accuracy of UK commercial property forecasts”

** See Cremers, M and Petajisto, A, “How active is your fund manager?” for a discussion of active share.

*** Investment Property Forum (Winter 2018/2019) “UK commercial property concuss forecasts”