Case closed? Examining the role of closed-end real estate funds in adding value to portfolios
- March 1, 2023: Vol. 10, Number 3

Case closed? Examining the role of closed-end real estate funds in adding value to portfolios

by Will Robson

What is it that investors hope to achieve by placing capital in closed-end real estate funds? Most would say it is to generate attractive risk-adjusted returns, but relative to what?

In general, closed-end funds are measured by an internal rate of return (IRR) against an absolute target over the lifetime of each fund. This choice of measure is commonly justified to account for the uneven timing of cash flows and typical J-curve profile of returns one expects to see over the life of the fund. Closed-end funds tend to engage in more actively managed, higher-risk and more levered strategies, especially when compared with open-end funds. The exposure of closed-end funds to higher-risk strategies should, all things being equal, come with higher return expectations; many expect closed-end funds to comfortably outperform a broad-based, unlevered benchmark.

Over the two years to June 2022, markets had been on the rise, by strong performance in industrial and logistics assets, particularly in the U.S., according to data from the MSCI Global Quarterly Property Index. Consequently, a closed-end fund manager with an IRR target of 12 percent levered who has been heavily exposed to that segment of the market had been able to massively outperform, potentially being paid handsome performance fees for simply riding the boom in industrial pricing.

Market movements affect all funds and strategies throughout market cycles to varying degrees. Everybody understands this, but performance measurement against a fixed hurdle ignores this, both on the upside when markets are booming and also on the downside when markets are sliding, and achieving a fixed hurdle becomes increasingly difficult. Finding a better way to identify funds that have added value beyond broad market exposure, therefore, would be helpful for investors and managers alike.


One way of doing this is by combining private real estate indexes with a public market equivalent (PME) calculation. MSCI has carried out this type of work on the performance of 145 U.S.-focused, closed-end real estate funds from the Burgiss Manager Universe, using the Burgiss Kaplan-Schoar Public Market Equivalent (KS-PME) calculator, with the MSCI U.S. Quarterly Property Index as a diversified, unlevered private property performance benchmark, rather than the more typical use of a public stock market index.

Broadly speaking, the Burgiss KS-PME calculator takes the same set of cash flows (in terms of timing and magnitude) that a fund manager has invested in a private real estate fund or portfolio and models the returns they would have generated were they invested into the MSCI benchmark. The KS-PME then provides a performance ratio between these two options. Any number above 1 shows outperformance of the index. A number below 1 shows underperformance.

The findings make interesting reading. On average, the closed-end U.S. real estate funds in our study outperformed the MSCI U.S. Quarterly Property Index by a factor of 1.07 from the funds’ inception dates through to December 2021. In other words, on average, over the life of closed-end funds, they returned 1.07 times as much as the index.

That is comparing a post-fee levered fund return against an unlevered pre-fee index return, however. Drilling down into each of the 145 funds, it is possible to find the loan-to-value (LTV) ratio of each vehicle over the course of its lifetime. Applying leverage synthetically to the benchmark in the same magnitude as the fund, produces an average PME of 1.01. Overall, then, the performance of closed-end U.S. real estate funds looked similar to what some might call “levered-up” index returns.

That said, there is still a very wide range across funds within the analysis. Even when adjusting for leverage, a number of funds still outperformed the market by quite a distance, but conversely, many funds significantly underperformed the index.


The analysis also has shown vintage matters, too — underlining the fact that closed-end funds do not operate within a vacuum: 72 percent of funds launched between 2005 and 2007, pre-GFC, underperformed the index on both an unlevered and levered basis. These made up one-third of all underperforming funds.

The returns of these funds were not just weak in an absolute sense. Because they were invested at the wrong time, they were also weaker than the market, generally. It appears that market benchmark comparisons are relevant for closed-end funds and should not always be discarded in return for sole use of IRRs against an absolute hurdle.

Using a property index in a PME calculation is perhaps an intuitive additional way of looking at performance to provide market context to closed-end fund performance analysis. Investors and managers could take this analysis further by carrying out assessments based on customized benchmarks that align with the property type and geography exposures of certain funds. Added layers to the analysis also may help allocators understand how much performance benefits from leverage, and how much from exposure.

This is a different way of looking at closed-end fund performance and may prompt asset owners to ask a few more questions about whether their closed-end fund exposures are delivering in line with their objectives as they look at PME analysis across their individual fund exposures and aggregated across their portfolios.


Will Robson is executive director and head of real estate solutions research at MSCI.

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