The Impact of Currency on Performance of European Non-listed Real Estate Funds 2017

This research examined the significance of currency risk and its management for European non-listed real estate funds in a number of ways. A survey of INREV investor members found a high level of sophistication in currency risk management strategies. This included currency hedging against a range of currencies and at different real estate levels (for example, the entire real estate portfolio or on an asset by asset level). Continual currency hedging was the preferred strategy, with forwards being the preferred hedging instrument. A range of hedging ratios are used, particularly higher (greater than 50%) hedging ratios. The impact of currency hedging was assessed based on the annual returns in the period 2001 to 2015 of four sample portfolios, with five different hedge ratios (0%, 25%, 50%, 75% and 100%). Risk reduction of between 25% and 36% was observed when the hedged portfolio was compared to the unhedged portfolio. Hedging ratios were seen to be more important than the choice between different forward hedging terms (such as three months or nine months), and transaction costs had minimal impact on risk and return. Forward-looking simulations were used to assess the effectiveness of different hedge ratios. Risk reduction of between 13% and 38% was observed when the hedged portfolio was compared to the unhedged portfolio. We identified an “optimal” hedging ratio under different conditions across four different sample portfolios and this ranged between 50% and 100%, with an average of 81%. Overall, this research has identified the impact of a wide range of key issues relating to currency risk management strategies in the European non-listed real estate fund space. In doing so, the research has highlighted the importance of using currency hedging when investors from different currency zones invest in European real estate. There is a strong connection between the investor survey results and the empirical analysis regarding hedging strategies, particularly at the higher hedging levels in the long-term analysis. The key findings highlight the importance of currency risk management for real estate investors seeking international real estate exposure in their overall risk management strategies. Whilst a high level of sophistication is currently evident amongst INREV members, specific results from this research will assist real estate investors in fine-tuning their currency risk management procedures for better real estate portfolio performance. Unhedged currency exposure has upside potential but downside risk too. Currency movements on their own can make the difference between a target being reached or missed. For managers of non-listed real estate funds, currency movements could spell the difference between a client retained and a client lost. This study shows that the optimal hedging ratio is likely to be somewhere in the range of 50% to 100%, and therefore blanket hedging is unlikely to be optimal in every case. So it is worth spending time thinking through the investment strategy and its currency implications, and considering how much of the associated currency exposure should be hedged. Setting the hedge ratio correctly will have more impact than any other single decision relating to currency. The research focuses on real estate investment in isolation, although in practice real estate is often part of a larger multi-asset portfolio in which currency hedging is decided and implemented at the overall portfolio level.