| First synthetic real estate hedge fund looks beyond brick and mortar |
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| 04/02/2007 | |
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A derivatives property hedge fund, the first of its kind, is being launched and it has no plans to invest in brick and mortar. The new entrant, Orn Capital will launch the hedge fund in March in a market that is still relatively small but growing in influence. "We are looking at property derivatives as a lead product," says Chris Iley, the fund manager. "Real estate equity funds will in time use property derivatives to hedge their positions. But for now we have a way to play the property market's forward returns by looking at fundamental macro economic drivers in various countries and sectors and looking at the relative value opportunities between them." Morley Fund Management, which took a 56% stake in Orn seeded the fund, which hopes to raise £100-150m this year. Burgeoning UK market The fund plans to invest in relative value strategies such as counterbalancing investments in the retail and offices sectors. According to Iley, this could raise the fund's exposure to two or three times the actual size of the fund. Iley will initially focus on the UK, a pioneer in the property derivatives market estimated at £4bn in 2006 compared to just £800m in 2005. While relatively small compared to other derivatives markets, volumes are growing thanks to the emergence of a credible index known as the Investment Property Databank (IPD), which enjoys extensive coverage in the UK. "Nearly 45% of the underlying market is valued in IPD, so it is a very accurate representation of underlying returns," says Iley. While the UK seems to have found a standard real estate benchmark, the US is currently grappling to find one, resulting in a more fragmented market that uses multiple property indexes. The UK market is mostly made up of total-return swap contracts. The first ever French and German trades were carried out recently and market participants expect property derivatives to take off this year. No landlord on this property In a typical trade, the fund will search for arbitrage opportunities between different property products and geographic markets, for example, locking in the spread by shorting office real estate, which on a relative value basis is overpriced based on forward return expectations, and going long retail (such as shopping centres), where forward return expectations are lower. "We spend time looking at arbitrage opportunities. The interesting thing is that we now have implied in the derivatives prices forward returns on the underlying property market, so that we can estimate what the market is inferring one or two or three years down the road and look at the relationship between forward interest rates and inflation expectations. The first swaps were done on French offices. We can then look at French offices versus UK offices and play different real estate cycles in different countries. In the UK, sentiment in retail is quite depressed at the moment so forward return expectations in that sector are quite low." The fund plans to first build a model or methodology for the UK market, which it hopes to eventually replicate and export to other markets. "Hopefully, there will be opportunities for us if we are short in the right market. It is an interesting time in the property cycle to be launching this type of a product because real estate has had three stellar years of growth and clearly we are getting to a more mature stage in the cycle. Pricing in the derivatives market is beginning to reflect that returns will flatten out from now. We are starting to see more divergent views in the market so we can expect volatility to increase and so, as we see more movement in pricing and value divergence from sector to sector or geographic market to market, it is going to create opportunities for us." VB |
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