A small but growing number of commercial real estate fund managers are trying to give individual and smaller-scale institutional investors access to high-quality commercial mortgage-backed securities through exchange-traded funds and mutual funds.
The move comes as the Securities and Exchange Commission in October published a report calling for greater access to private funds for individual investors, arguing that there will be a rise in demand as retirement planning shifts toward individually managed accounts.
While investors have long had access to real estate investment trust securities, securitized debt has been the domain of the larger institutional investors, says Karen Schenone, a fixed-income product strategist in BlackRock’s global fixed income group.
“For a lot of investors, when they think about real estate, they think about REITs first. They’re probably less familiar with some of these debt structures,” Schenone tells Real Estate Capital USA.
Bridging the gap
BlackRock, which has operated its $800 million iShares CMBS ETF since 2012, sees a larger and broader audience for the fund due to the credit quality of the underlying securities and the in-place income.
The passively managed ETF mirrors the Bloomberg Barclays Aggregate Fixed Income Index and holds a basket of high-quality CMBS, with underlying properties that mainly comprise multifamily assets. There are a handful of securities from other sectors that include retail, office, lodging, industrial and self-storage, Schenone says.
The fund’s current portfolio is comprised of bonds with a weighted average life of about 5.5 years, with yields of about 1.5 percent. “The credit quality is about 90 percent AAA-rated,” Schenone says.
The ETF posted a solid 7.84 percent return in 2020. This is slightly better than the $88 billion iShares Core US Aggregate Bond fund, the largest fixed-income ETF in the world, which returned 7.43 percent during the same period.
“I could see this being a great way for an insurance company that wants to add CMBS or an offshore investor that is looking for higher yields and wants to diversify away from government credit,” Schenone says, noting that there needs to be more education around how the asset class could enhance a portfolio. “CMBS is under-represented in people’s portfolios.”
Mutual fund focus
RiverPark Funds, a New York-based investment management company, runs an actively managed open-ended CMBS mutual fund that is focused primarily on highly rated single-asset/single-borrower bonds.
The fund was one of the first in the mutual fund space, which meant RiverPark spent a good deal of time educating regulators about CMBS, how it behaves and has performed historically, and its liquidity features, says Ed Shugrue, RiverPark’s portfolio manager.
The RiverPark fund is focused on single asset/single borrower deals from institutional quality sponsors, Shugrue says.
“Right now, the fund is comprised of all income-producing assets that are 95 percent leased to institutional sponsors that include Blackstone, KKR and Fortress Investment Group. [These bonds] have an average LTV of 50 percent,” Shugrue says.
Despite the strengths of the sector, there continues to be obstacles to the ability of the CMBS market to attract the same scale of investment as mutual funds and ETFs in other sectors. One issue is the negative impression many investors continue to have of mortgage-backed securities because of what unfolded in the residential sector in 2008.
“The investment-grade bond market is about 2 percent of the bond market, it’s a pretty small component of it,” Schenone says. “If you’re looking to diversify away from just pure government bonds, this is the highest quality way to do it in the market.”