The importance of private equity real estate (“PERE”) funds has been growing dramatically in recent years. Through the first half of 2007, PERE funds continued to expand in terms of their number and average size. Although several high-profile takeovers of large publicly-traded real estate entities have underscored the influence of PERE funds, relatively little is known about them. Questions which have arisen regarding such funds include: what are PERE funds and what distinguishes them from other types of real estate investment vehicles? Why have they attracted so much investment capital? And, what are their prospects in a post credit crunch environment? These are among the issues we address in this paper. In addition, our research discusses why and how Canadian pension funds in particular, are making use of PERE fund vehicles within their investment portfolios.
We begin by noting that, until recently, there has been little research on PERE funds in Canada or elsewhere. This may be because their activity has not historically constituted a large portion of the overall real estate investment universe. It may also reflect a lack of available data because, as predominantly privately-held entities, PERE funds are not required to disclose details regarding their activities nor financial performance. Our findings are based on: (a) interviews with several PERE fund managers (both from the U.S. and Canada); (b) interviews with executives from Canada’s largest pension funds; (c) data compiled by Private Equity Intelligence Ltd., a British-based, global PERE fund database; and (d) relevant academic and popular publications.
How do markets arrive at prices? There is perhaps no question more central to economics. This paper focuses on understanding the behavior of prices in financial markets, where the following question looms especially large: How, if at all, is news about macroeconomic fundamentals incorporated into stock prices, bond prices and foreign exchange rates?
The process of price discovery in financial markets remains poorly understood. Traditional “efficient markets” thinking suggests that asset prices should completely and instantaneously reflect movements in underlying fundamentals. Conversely, several influential authors have recently gone as far as to assert that asset prices and fundamentals may be largely and routinely disconnected. Experiences such as the late 1990s U.S. technology-driven market bubble would seem to support that view, yet simultaneously it seems clear that financial market participants pay a great deal of attention to data on underlying economic fundamentals. The notable difficulty of empirically mapping the links between economic fundamentals and asset prices is indeed striking.
It is now widely agreed that, although daily and monthly financial asset returns are approximately unpredictable, return volatility is highly predictable, a phenomenon with sweeping implications for financial economics and risk management (e.g., Bollerslev, Engle and Nelson, 1994). Of course, volatility is inherently unobservable, and most of what we think we know about volatility has been learned either by fitting parametric econometric models such as GARCH, by studying volatilities implied by options prices in conjunction with specific option pricing models such as Black-Scholes, or by studying direct indicators of volatility such as ex-post squared or absolute returns. But all of those approaches, valuable as they are, have distinct weaknesses.
