In the latest Bayfield Training Webinar, Frank Ametefe and Sonia Martin-Gutierrez present: Should we add listed assets to our direct real estate portfolio to boost liquidity?

This webinar discussed the suitability of liquid assets such as listed real estate and other liquid assets for inclusion in a direct real estate portfolio. The popularity of defined contribution pension funds has led to an increased emphasis on liquidity by investment managers and the practice of combining direct and listed real estate to create hybrid real estate portfolios. Furthermore, the webinar discussed how optimization techniques can be applied to improve the performance of hybrid portfolios.

As Frank outlines, the bulk of his presentation is based on a paper in which he co-authored that was published in 2019 in the Journal of property, investment and finance. The title of the paper is: Optimal composition of hybrid/blended real estate portfolios. The purpose of the paper was to “establish an optimum mix of liquid, publicly-traded assets that may be added to a property fund portfolio to provide the enhanced liquidity required by institutional investors…”

Liquidity, in this context, refers to the ability of investors to sell assets quickly, with minimal loss in value from executing a trade, and at a low transaction cost. As such, the focus is on market liquidity. Market liquidity refers to an asset’s ease of conversion into ready cash without affecting its market price. Cash, of course, is the most liquid asset. When attempting to sell a specific asset, liquidity risk refers to the possibility of a significant downward price revision. In a stressed market, the seller may be forced to accept a price far below their perceived value.

Open-ended funds are a potentially attractive route for many investors who wish to access a diversified portfolio while holding reasonably liquid units. These foreign units are usually not traded on a secondary market; investors who wish to exit open-ended funds must sell the units back to the fund. Similarly, investors who want to join the fund will also need to deal directly with the fund. To facilitate trades, many of these funds tend to hold a certain amount of cash which limits returns.

After market-stress events, such as COVID or Brexit, there is always an increased emphasis on liquidity by different parties, including regulatory agencies, investment managers, and pension fund trustees. Generally, investment funds are forced to hold more cash during market-stress events. In addition, if there is persistent and significant redemption by investors, fund managers may even be forced to dispose of assets at lower market prices, which further affects the fund’s value and the return the fund can generate.

Frank explains that the use of liquid assets, other than cash, to minimize the loss in return that investors experience when cash is added to the portfolio has been explored for quite some time within the real estate literature. It is only recently that several property funds have started to offer products based on this idea. For example, Legal and General’s hybrid property Fund invests in both direct real estate and listed real estate on a default split of around 70/30.

Frank explains that the idea of including listed real estate in a direct real estate portfolio to diversify a portfolio and infuse a certain amount of liquidity is not new and has been a point of contention in academia since the early 2000’s.

Ten years later in 2011, the National Association of Real Estate Investment Trusts (NAREIT) looked at the same issue. Frank clarifies that NAREIT explored the benefits of blending listed and direct real estate, concluding that the optimum blend of private and listed real estate would provide better risk-adjusted returns than holding either of them separately. NAREIT recommended that you should hold about a third of your portfolio in REITS or listed real estate. A similar study confirmed that adding listed real estate to a UK direct property holding would enhance returns. However, one problem they found with this strategy was that it tended to increase the tracking error, which is a fund’s ability to make or produce returns that are broadly in line with the benchmark.

Frank explains that in the paper he co-authored, they decided to expand the universe of liquid assets for inclusion in a direct real estate portfolio beyond cash and listed real estate. According to Frank, this was done to allow an optimizer to pick the combination of assets that will help minimize the tracking error between the blended portfolio created and the direct real estate benchmark. Liquid assets included were cash, listed real estate, general stocks, and bonds of various maturities. They used the main error optimization procedure. This procedure selects a combination of assets that will produce the lowest tracking error relative to the direct real estate benchmark. In simple terms, the tracking error is the standard deviation of the difference between the return of a particular asset and its benchmark.


Frank explains that they constructed two sets of optimized portfolios, one with no return constraint and the other with a minimum return constraint. For the constraint optimization, they set a constraint that the return of the resulting portfolio should be equal or greater than the average return on the direct real estate benchmark.

For each optimization, the proportion of direct real estate was kept at a predetermined level. Each of the portfolios created contained different levels of liquidity (10%, 20% and 30%).

An interesting observation Frank and his co-authors found was that allocations tended to change in line with the allocation to the liquid asset portion of the portfolio. For example, the unconstrained portfolio consistently allocated 80% of the liquid asset component to cash, 12% to listed real estate, and 8% aggregate stocks.

However, with the imposition of the constraint (i.e. direct real estate), the allocation to cash drops from 80% to 25%. Long-dated bonds make up 33%, listed real estate 19%, and aggregate stocks roughly 23%. Moreover, they found that the unconstrained portfolio had the lowest

Out-of-sample Allocations

Next, Frank compared an out-of-sample mix portfolio with no minimum return constraint relative to one with a minimum return restraint. The unconstrained portfolio was initially heavily invested in cash. However, following this, the portfolio began to allocate more to aggregate stocks and listed real estate, which averaged rougly 40% of the liquid asset component of the portfolio. Frank explains that this allocation occurred during the 2007/08 financial crisis. The portfolio with a minimum return constraint, was significantly more diversified with aggregate stocks, and long-term bonds receiving allocations, in addition to cash and listed real estate.


In sum, the study found that a combination of listed and direct real estate produced the highest average return. It was the only strategy that recorded return enhancement with each increase in the liquid asset component. Return dropped relative to the direct real estate benchmark whenever a liquid asset was added with the other strategies. However, Frank cautions that the return advantage associated with the listed and direct real estate portfolio combination comes with a much higher standard deviation and tracking error.
Ultimately, Frank’s study suggests, “real estate fund managers can realise the liquidity benefits of incorporating publicly traded assets into their portfolios without sacrificing the ability to deliver real estate-like returns. However, to do so, a wider range of liquid assets must be considered, not just cash.” In other words, open up your portfolio to a more diversified set of liquid assets.