A couple of days ago, our investment analyst Choon Siong forwarded me this hilarious piece of commentary on the Financial Times.
The chart below shows the performance of six real estate investment trusts, five mainly listed in the United States:
For the past year, the performance of five of the trusts has been bunched together.
There was an outlier: Breit Class I Nav.
Breit Class I Nav is Blackstone’s Real Estate Income Trust fund. Breit, as of September, has a debt-to-equity ratio of 1.6 times and less than 10% of its debt is due within the next two years. 55% of the portfolio is residential housing, and 23% is industrial. By reputation, it has high-quality properties.
David Auerbach, who runs the fund, sums up the puzzle: “How can everyone else’s valuation be going down, and theirs is going up?”
As a private REIT or a private equity fund, Breit does not have to mark the value of their fund to market, unlike the other five.
Either Blackstone is damn outstanding as a manager, and the others are so shit (they are all in the same residential and industrial sector) that they can select the properties in regions where the price is not going down.
Or that all this is because… they haven’t mark-to-market!
If you are an investor in Breit, a trade would be to sell your stake in Breit and buy these publicly listed REITs, backed by physical properties, at a 25% discount.
But the manager at Breit tells you that you cannot get back your money.
Imagine you are a manager of the fund or any fund. If 20% of your unit holders wish to redeem their units, and you don’t have the cash to pay them, you have to liquidate some of your positions.
Now, what does liquidating your positions mean? Selling some properties to get cash so that they can pay you.
But if they sell the properties when urgent, can they fetch a good valuation? Most likely, they have to sell lower.
These unlisted funds are just illiquid.
If there is a stampede, the mark-to-market will happen.
This is not to say the assets in Breit are going to turn to shit:
On 3rd Jan 2023, the University of California announced they would invest in Breit. This should provide some much-needed liquidity. I think as a show of confidence (perhaps to motivate the University of California), Blackstone will be committing $1 billion of their capital as well.
This should provide additional liquidity to tide them through this period.
We get the returns and the emotional ride we deserve
This case study eerily reminds me of an upcoming rug-pull scene from a Defi crypto project that you lock in your tokens by staking.
Great returns, but when you want your money, you realize… you cannot withdraw.
This is likely not the case, but in this instance, you should understand that illiquidity is a characteristic of private equity that you must live with. You cannot suka suka sell anytime that you want.
- More affluent investors like the appearance of low volatility, which means that their performance looks better risk-adjusted (standard deviation is lower because there is less mark-to-market, so the performance looks better!)
- They also like to use leverage, and so these funds use leverage to such a degree that it satisfies them.
- There is a promise of good returns, and the affluent would pay up for it in big fees, which some may not realize how detrimental that could hurt performance.
Many investors are out there trying to find that holy grail of
- Low-volatility or capital guarantee,
- Very emotionally comfortable investment journey.
So they either found scams or pretenders.
In this case, the pretenders are:
- Solutions or strategies whose tail-risk is more significant than your perception.
- Great returns are always possible in great managers who don’t need your money, which you don’t have access to.
- In most times, the volatility is as you expected until events that you least expect, which spikes the volatility to such a degree that you realize this investment is more significant than your emotional threshold.
- One day you realize the returns are just like a typical retail fund return, but the fees you pay are huge relative to retail funds. That is when you realize you are a vegetable head.
- There is nothing special. If everyone crowds into something, the premium eventually disappears, and there is no outperformance. Value, and illiquidity premiums also disappear.
Eventually, you may realize that investments you come across have different returns, volatility, risk, effort, and emotional journey characteristics.
There is seldom a holy grail and the surge is quite futile.
The uncomfortable truth is that you exchange a less-than-comfortable emotional journey filled with volatility, capital-impairment risk, and effort for better returns.
Asymmetric-return opportunities exist but are usually presented through a lot of extra effort, very testy emotional journeys.
Even after this, people will be searching for that high-return, low-to-no-risk investment.
And most often, I think they will get the returns and the emotional ride they deserve.
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