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LARGEST MONEY MANAGERS: Alternatives

Good returns, strong fundraising benefit alternative firms

Survey finds more winners than losers among sectors; infrastructure, commodities, CDOs jump double digits

Brad Case, senior vice president, Nareit
Brad Case believes investors are avoiding REITs, thinking technology stocks offer better returns.

updated with correction

A heady brew of returns and fundraising success gave a lift to alternative managers' assets, but only three sectors saw double-digit growth in 2017.

Even so, the current survey results tell a far happier tale than in 2016, when managers in all but four alternative investment asset classes tracked by Pensions & Investments annual survey lost assets.

Five alternative investment sectors witnessed aggregate declines in U.S. institutional tax-exempt assets under management as of Dec. 31, P&I's annual money manager survey showed.

Areas with the highest increases in AUM were infrastructure, up 37%; commodities, 19%; and collateralized debt obligations, 18.8%. Other areas showing gains during 2017 were private equity, up 9.7%; privately placed debt, 9%; real estate equity, 8.5%; and buyout funds, 7.8%. However, the private equity sector gains are all from small bases.

This year, in the real asset sector, aside from infrastructure and real estate, master limited partnerships was the only subasset class with AUM growth, ticking up 1.8%, while energy dropped 11.5% and timber was down 3.6%.

Mixed results for credit

Credit, a big theme for investors over the past several years, also had mixed results. Mortgages in the form of whole loans increased 3% and mezzanine debt grew by 2.3%, while distressed debt plummeted 23.5% and bank loans were down 5.4%. Meanwhile, assets of hedge fund managers, many of which have credit exposure, dropped 14% to $105 billion.

Real estate investment trusts had a bit of a comeback with REIT manager assets showing 5% growth, after dropping 3.8% in the year-earlier survey.

"The returns for 2017 were positive in general," noted Joseph Chi, Santa Monica, Calif.-based vice president and co-head of portfolio management at Dimensional Fund Advisors, commenting on REIT returns.

However, the growth in assets did not match returns during the survey period. The FTSE NAREIT All REIT index gained 9.27%, and the FTSE Nareit Equity REIT index returned 5.23% for the year ended Dec. 31.

Brad Case, senior vice president, research and industry information, in the Washington office of REIT trade group Nareit, said the common wisdom hindering REIT investment is the securities' volatility and underperformance relative to the broader equities market due to fears of rising interest rates.

But he has a different theory. Much like the dot-com era, Mr. Case said, investors that use REITs as part of their equity allocations are reallocating capital into technology stocks because of overconfidence in their earnings potential. "Not every income-oriented investment behaves the same, " Mr. Case said.

REIT quandary

REIT underperformance has nothing to do with the fundamentals of the underlying properties because real estate equity returns have been solid, Mr. Case said.

In 2017, for example, REIT returns were a fraction of equity returns, with the Russell 2000 at 14.65%. However, REITs topped real estate equity returns by around 2 percentage points.

The NCREIF NPI total return was 7% and the NCREIF Open End Diversified Core Equity return was 6.68% net of fees for the year ended Dec. 31.

At Dimensional Fund Advisors, returns were only part of the REIT growth story. "We do manage global strategies, not just U.S. REITs and we saw inflows into our funds," Mr. Chi said.

Dimensional retained the top spot on P&I's ranking of REIT managers, with a 35% rise to $17.8 billion. Nuveen held on to the second spot with assets up 7% to $11.7 billion, while Principal Global Investors moved into third place from fifth, with REIT assets growing 21% to $8.6 billion.

REIT managers have to bring something else to the table due to REIT underperformance compared to equities, some managers featured in the P&I survey said.

"Public markets for real estate have not performed very well," said Craig Noble, Chicago-based senior managing partner at Brookfield Asset Management, and CEO and chief investment officer of Brookfield's public securities group.

"Investors are looking to us to be a deeper value investor, that captures upside when markets go up and at the same time, provides downside protection," Mr. Noble said.

Brookfield was in the seventh place on P&I's top REIT manager list and the 10th position on this year's real estate equity manager rankings. Brookfield's REIT assets grew by 30% to $4.7 billion, while its real estate equity assets were up 33.5% to $13.6 billion.

"On the private side, each of the private real estate funds has been bigger than the prior fund and we are still young enough in the lifecycle of these funds that we are stacking one fund on top of another in terms of AUM," Mr. Noble said.

Last year, Brookfield closed on Brookfield Real Estate Finance Fund with $3 billion.

No change in top 3

This year, the top three real estate equity managers held onto their positions. Nuveen still tops P&I's list of the top real estate equity managers with assets up nearly 10% to $53.9 billion. J.P. Morgan Asset Management (JPM) is second with assets increasing 4% to $43.6 billion and Legg Mason (LM) is third with its AUM up 3% to $29 billion.

Much of the growth was due to clients' growing appetite for real estate, which remains undiminished in 2018, said Mike Sales, London-based head of TH Real Estate, a real estate subsidiary of Nuveen.

Last year, for example, TH Real Estate closed its seventh multifamily fund with $400 million and it raised an additional €422 million ($586.7 million) for its European cities open-end fund, bringing total fund assets to about $1 billion, Mr. Sales said.

"We also pivoted from the equity side to the debt side, with a 40% increase in debt exposures, mainly on the senior (debt) end," Mr. Sales said. "From a fund perspective, we completed the cycle for U.K. Debt Fund I and have now launched a U.S. debt fund."

In infrastructure, there was no change among the top three managers of U.S. institutional, tax exempt assets. IFM Investors Pty. Ltd. is again in the first position, with assets managed internally for U.S. institutional tax-exempt clients up 15% for the year to $6.8 billion as of Dec. 31. Brookfield Asset Management is second with infrastructure assets up 40% to $6.5 billion and J.P. Morgan Asset Management is third with a 5.5% gain to $3.3 billion.