One of the biggest arguments within the financial services industry has been about active vs. passive investment strategies. Active managers make the case that by selecting specific investments, they can outperform a benchmark index, while passive managers try to simply match the returns of a benchmark index, often at lower cost.

Over the past decade, more than three trillion dollars have flowed to passive equity investing strategies. According to Morningstar, passive funds now hold 48% of investment assets. They’ll top 50% in 2019 if the current trend holds.

Investors are attracted to low fees, more liquid products, better diversification, but also outperformance. In each of the last ten years, the “SMARTEST” investors (hedge funds) have underperformed the S&P 500. Since the beginning of 2009, the S&P 500 has outperformed Hedge Funds by an average of 8.5% a year.

Long-only mutual fund managers have fared even worse, with only 38% of active managers outperforming their benchmark in 2018. Over the long-term, active managers perform even worse:

Passive Investing has proven to be the winner in the equities space.

At Compound, we believe in passive investment strategies across all asset classes, including real estate.

Real estate investors have yet to adopt passive strategies within real estate primarily because the products have not yet been created and while the powers that be within the industry will defend active management all day long, we’re confident that enhanced transparency and evaluation will lead to the same result as other asset classes.

Let’s take a look at how active managers do within the real estate industry.

To analyze this, we need to start with a benchmark. Green Street’s Commercial Property Return Index is a time series of un-leveraged U.S. commercial property income and values using over $600 billion of institutional quality real estate assets.

Next, let’s look at the returns for active managers. NCREIF is the leading provider of investment performance indices and transparent data for US commercial properties. Their property returns, also measured on an un-levered basis, are sourced through surveys from some of the most successful private real estate firms in the U.S. including Blackrock, Calpers, Guggenheim, Invesco, and Morgan Stanley--all really really smart firms.

Do these really smart active managers outperform the benchmark?

Take a look:

Green Street came to the same conclusion over an even longer timeline:

What does this all mean and where does it lead?

We think that the migration from actively managed strategies to passive strategies that has already occurred in ALL other asset classes (equities, fixed income, commodities, listed real estate) will also occur in private real estate.

Why is this good for investors:

  • Fees will come down
  • Net returns will go up
  • More liquidity
  • More transparency

This is a big opportunity for Compound.