June 2009 Issue: Key Points

This month's feature article examines the disappointing performance of global commercial property as an asset class over the past 18 months, particularly relative to global equities. We identify the fundamental valuation and investor behavior factors that seem to have been responsible for property's underperformance - negative views of the future growth of free cash flow from property, and a sharp rise in uncertainty tied to property companies' and partnerships' ability to rollover their maturing debt. We also analyze why correlations across global property markets have been so high relative to expectations, and conclude that while previous research correctly identified the presence of a global GDP growth factor as a driver of property returns, the asymmetric nature of its impact on the downside was underestimated (and the potential impact of a global liquidity and credit crisis was essentially ignored). We also review the contentious issue of whether there is any difference between property that is directly held and property that is held in a securitized form, as in the case of REITs. Economically, the most recent research, which properly adjusts different indexes to make them comparable, concludes that there is no difference beyond the lower liquidity of direct property investments. However, we also note that from a behavioral perspective, direct property is less exposed to investor overreaction driven by emotions and social interactions. In addition, the appraisal based valuation of direct property investments tends to reduce the portfolio impact of fluctuations in underlying values over time. Depending on your perspective, this may or may not be beneficial.

Next, we look to the future, and conclude that the lessons learned over the past 18 months have weakened the case for holding commercial property in a portfolio, while also strengthening the case for making allocations to a single developed markets property asset class rather than distinguishing between local and international property asset classes.

In our economic update, we conclude that the current enthusiasm for "green shoots" will likely weaken over the coming months, as the continuing reality of high household debt levels, a weak banking system, and a very strained international system continue to exert strong downward pressure on real GDP growth. We also conclude that, as is true of the recent increase in equity prices, the recent upturn in prices for inflation hedging assets is also premature, and that assets that hedge against uncertainty seem undervalued today.

In this month's product and strategy notes, we take an extended look at how regret aversion affects investment decisions, and compare the impact of errors of commission and omission over short and long periods of time. Human beings try harder to avoid errors of commission, even though research shows that the economic cost (and, over the long term, the emotional cost) of errors of omission is often greater. We conclude with two recommendations for avoiding these traps: first, being aware of them, and second, improving foresight accuracy by getting a range of independent (and sometimes conflicting) advice before making important decisions.

| June 2009 Issue: Key Points | This Month's Letters to the Editor: Fidelity vs Schwab vs TD Ameritrade - Opinion?; Index Investors' Allocation Models vs MVO Models - Superior? Yes; Asset Class Valuation Updates: Possible, Likely and Probable - What They Mean; and Commodity Valuations Long/Short (LSC) or Long-only Fund? | Global Asset Class Returns | Uncorrelated Alpha Strategies Detail | Asset Class Valuation Update | The Role of Property in a Portfolio, Given Recent Experience | June 2009 Economic Update | Product and Strategy Notes: Powerful Impact of Regret; More Research - Why Successful Actively Managed Funds are Rare; Did the Media Do a Good Job Predicting the 2008 Crisis?; and How Rigorous is you Investing Logic? | |