Category Archives: General

Developments in European regulation on securitisation

Since 20th June 2013 newly amended regulation has come into force expanding the scope and application of disclosure requirements for structured finance instruments.

The newly amended CRA3 demands that issuer, originator and sponsor of a structured finance instrument jointly publish information regarding the structured finance instrument on a website to be set up by the European Securities Markets Authority ESMA.

The information to be published is quite extensive and includes detailed credit information and performance of the underlying assets.

It further requires for any public or private structured finance transaction to be rated by two agencies. While this was fairly standard for the public transactions, this is entirely new for private deals.

Altogether this clearly represents another hurdle for securitisation in Europe, with the possible impact of falling even more behind US market growth.

CRE ETFs in investor asset allocation strategies

Pension, insurance funds and other investors are looking for alternative asset allocation methods to include real estate as an asset class. According to Consilia Capital and Property Funds Research in a study published by EPRA (European Public Real Estate Association, 2013) real estate securities funds have grown by 68% in AUM between 2007 and 2012 and by 39% in number of funds. This figure also includes CRE ETFs. One key advantage supporting this growth is the liquidity of real estate securities funds in general. This allows investors to react quickly to market changes.

But there are additional advantages choosing a CRE ETF instead of a real estate securities fund. While they offer the same return profiles and volatility, trading costs are significantly lower and liquidity is guaranteed through a registered stock exchange. They are even more liquid allowing for intra-day trading strategies being executed to gain access to very short term returns, for instance due to intra-day differences in trading price vs fund NAV.

CRE ETFs also provide investors with more flexibilities to adjust to market changes in the underlying real estate market by allowing to shorten a specific market. Just like individual shares, CRE ETFs can be sold short. For example an investor may choose a diversified portfolio of real estate stocks or a real estate private equity fund as their core real estate investment, but before they can exit, the market declines. The investor can now short his exposure in the segment using a CRE ETF as a hedge.

A similar strategy is possible for investors in specialist real estate private equity funds, by choosing a special CRE ETF tracking a specific benchmark such as UK industrials, although the hedge might not be as perfect. Options are limited in Europe through the limited amount of specialised real estate property companies. In addition the sector allocation through a basket of listed real estate securities might not be as purist as with a real direct property investment.

Trading CRE ETFs can also be a intermediate strategy for private pooled real estate funds to breach the gap until an appropriate property has been found. Investors will receive a real estate return with the same liquidity as a money market fund at a very low trading cost. There is also no minimum investment amount, because these products are essentially designed for retail investors.

What about real estate ETF investment strategies?

There are a number of strategies used by ETFs that are not available to other real estate fund managers, which provide the ETF with more flexibility to react to market changes. ETF fund managers can follow a very passive strategy, these funds track an index, but funds can also be actively managed. There is no limit as to how actively they can manage the portfolio to focus on alpha strategies.

Figure: alpha-beta strategies road map

beta
Source: Deutsche Bank, 2012
For example the majority of real estate ETFs are passive investments, meaning they track a benchmark index. Examples for passive beta strategies are:

  • iShares FTSE EPRA/NAREIT Asia Property Yield Fund
  • iShares FTSE EPRA/NAREIT Developed Markets Property Yield Fund
  • iShares FTSE EPRA/NAREIT UK Property

Few funds use a different approach than market capitalisation, considered smart or adjusted beta such as

  • BMO Equal Weight REITs Index ETF (ZRE-TSX)
  • PowerShares KBW Premium Yield Equity REIT Portfolio

There is currently only one true active fund, which differs in the asset allocation approach:

  • PowerShares Active U.S. Real Estate Fund

Invesco’s PowerShares Active US fund uses quantitative and statistical metrics to identify attractively priced securities and manage risk.
Physical ETFs can use the full spectrum of asset allocation tools for increasing or decreasing exposure to a specific style, sector or capitalisation

  • Sector rotation strategies
  • Arbitrage strategies
  • Hedging and defensive strategies
  • Stock-lending revenue strategies (from short sellers)
  • Market neutral strategies
  • Maintaining exposure during a manage transition
  • Hedging tools for shorting
  • Transition management

Being able to sell stocks shorts, provides the ETFs with downside protection in a crisis.

Synthetic ETFs

on the other hand are not based on stocks directly. They deliver the performance of the index they track via a swap contract. This technique allows them to have a smaller tracking error than conventional funds. The ETF manager builds a so-called “substitute basket” – sometimes also called “collateral basket” – these are assets of good credit quality delivering a low but risk-free return. In addition he enters into a swap contract with a counterparty – normally an investment bank – whereby it exchanges the performance of such a basket for that of the index.

Leverage

Not all ETF’s are based on stocks. Some are based on derivatives, such as options and futures. For example commodity ETFs use futures to replicate the performance. The use of derivatives allows leveraging to do a multiple of what the market index does. Leveraged ETF’s seek to make 2 or 3 times the return of their target index, while leveraged inverse ETF’s seek to earn a multiple when the target index declines.
While these types of ETFs are much more common for commodities, there are currently only a couple of real estate ETFs using leveraged performance. Two noteworthy examples are applying a beta multiplied strategy are:

  1. Direxion Real Estate Bull 3X – Triple-Leveraged ETF
  2. Direxion Real Estate Bear 3X – Triple-Leveraged ETF

These funds deliver 300% (3x) of a selected benchmark index. They create short positions by investing at least 80% of their assets in derivatives: such as futures contracts; options on securities, indices and futures contracts; equity caps, floors and collars; swap agreements; forward contracts; short positions; reverse repurchase agreements (REPO); exchange-traded funds (“ETFs”); and other financial instruments that, in combination, provide leveraged and unleveraged exposure to selected index. The remaining is typically invested in short-term debt instruments that have terms-to-maturity of less than 397 days and exhibit high quality credit profiles, including government securities and repurchase agreements.
Leveraged ETF’s are generally used for short-term trades — not as long-term investments, since markets go up and down, so gains and losses are both amplified.
The largest provider of physical real estate ETFs is Blackrock through it’s ishare brand. Main stock exchanges are NY, London and Canada.
Figure: Fund manager and number of funds

managers

Source: Nicole Lux

Next week: AUM, how large is the investment universe, what about performance?

New European CMBS issuance rules 2.0

The April issue of Real Estate Capital confirms investor interest in reopening and reviving the European CMBS market.

Changes to the new style CMBS demanded by investors are around information disclosure, independence of advisers and most importantly control rights in events of default.

While some suggested changes are helpful such as the ability to sack property managers without cause after a loan default, with managers obliged to transfer information, selecting and negotiating with a new property manager can be a lengthy process and requires in-depth knowledge of what is needed to transform the assets into a performing loan.

Many requests address rights of the controlling class, noteholders should be aware though that where only a portion of the loan has been securitised this controlling party is often the B-noteholder or subordinate lender, who has different interests from the senior bond holders. In addition the senior noteholders are in most cases not real estate professionals.

Of course terms of engagement of rating agencies are not a secret and follow defined fee structures. It is up to investors to enquire.

http://www.crefc.org/Global/CMSA-Europe/Committees/European_CMBS_2_0_Committee/European_CMBS_2_0_Committee/