Investment Styles and Style Boxes in Equity Real Estate: Can the Emerging Model Succeed in Classifying Real Estate Alternatives?

Journal of Real Estate Portfolio Management, Jan-Apr 2005 by Kaiser, Ronald W

Interviews with Consultants and Advisors

The input for this paper consists of a collection of sources: telephone interviews or the author's RFP experience with eight general consultants to pension plans and endowments; RFP and other experience with several specialized real estate-only consultants; interviews and experience with five different real estate advisory firms; as well as the NCREIF paper itself, in detailing two typical investor responses. Out of this process, there arose not only several thoughtful discussions mostly within the author's firm, but also with one general consultant who was laboring independently to draft a styles white paper.

Setting the Scene: Overview of Style Boxes in U.S. Public Equity Investing

Statistical Boundaries of Equity Universe Based on Size and Valuation

In the equity market in the United States, investment styles are defined by carving up the entire universe of publicly-traded stocks-by size (market capitalization), valuation (value vs. growth), or sometimes by specialty (industry sector), as shown in Exhibit 1. Market cap segmentation is simply the process of ranking all stocks by total outstanding share value, and drawing arbitrary lines at certain percentage points along the spectrum. Stocks can migrate across the boundary lines as prices change, although the boundaries and definitions are reset at least once each year. While the valuation definitions can vary by consultant-where value can be defined by price-to-book, price-to-earnings, dividend yield, price-to-earnings growth, or some custom formula-the process still becomes one of statistically carving up the existing universe as selected by the consultant or by an index provider such as Frank Russell or Morningstar.

Performance (Return and Risk) is Observed From the Style Box Universe

Once a style box is defined, all the known securities can be selected, and the performance can be determined by constructing a benchmark portfolio made up of all stocks in that box. The relative risk and return can vary over time between style boxes. For much of the 1990s, high tech growth stocks dominated the return race, while the past three years has seen small cap value stocks lead the return parade. Style boxes are not selected based on a priori expectations about return and risk.

Creating "Alpha4" from Anticipative, Quantitative, or (Small) Style Drift Strategies

When a manager is hired to provide a certain style box approach for an investor, the individual is expected to invest almost exclusively within the selected universe. Further, the manager is legally prohibited from using any information but that which is deemed publicly available.

Winning managers can employ some combination of superior judgment selection (anticipating which firms and stocks will perform better), superior quantitative modeling and selection, superior diversification technique, and/or superior trading skill in an attempt to outperform the benchmark (create an "alpha" for a given "beta" or volatility approach). This formula is summarized in Exhibit 2.