Broadcast Retirement Network’s Jeffrey Snyder discusses how employers can include real estate in their retirement programs (401k, 403b and 457b) with Francis Investment Council’s Edward McIlveen, CFA.
Jeffrey Snyder, Broadcast Retirement Network
Three, two, one. Ed, it’s so great to see you. Thanks for joining us on the program this morning.
Edward McIlveen, CFA, Francis Investment Council, LLC
Thank you. Thank you very much.
Jeffrey Snyder, Broadcast Retirement Network
And I really appreciate you and your colleague, Michael, coming on the program in the last few weeks. It’s always great to talk to people who are so knowledgeable, have that fiduciary responsibility and remain independent. It really is important to the retirement ecosystem.
Ed, what I wanted to talk to you about this morning was to get a sense from you. You do a lot of work with defined contribution, like 401K, 403B, 457 plans. Is there an interest in the inclusion of real estate in those plans?
Edward McIlveen, CFA, Francis Investment Council, LLC
Well, thank you, Jeff, for the question. What we have seen over the last 20, 25 years or so is really an evolution in the demand for this kind of asset class. And usually, the conversation comes up around REITs.
That is usually the first starting point. And this is distinct from direct real estate. So as time has moved along over the last 20 years or so, I think people just looked at real estate as REITs being one and the same.
And they’re really not the same thing. The biggest divergence that you started to see around this was around things like when Amazon, known as the Death Star, started to take out all of these shopping malls, when COVID came along. And then all of a sudden, the office space starts to come unwound.
And now what we are seeing is committee members, they take a look at the world around them. And perhaps in the past, they would walk through a shopping mall and say, gosh, isn’t it great that we as an institution can have access to this, make it available for our members and our participants. And now the conversation has changed quite a bit.
And so there’s a change in the business environment that has, I think, really taken away the luster of this asset class. And still, sometimes people really want to talk about REITs in particular. They hear about the data centers.
They hear about the new opportunities within the marketplace around that. And I think now the conversation has really started to change into what are some good inflation hedges. And we really didn’t have to worry about inflation until 2022.
And I think it was just always assumed that REITs and direct real estate were the same thing. But you saw a pretty big divergence in returns in 2022, where REITs all of a sudden lost about 25 percent. Direct real estate, if you owned it, was up into the single digits.
So it really hasn’t focused on being either something that’s particularly attractive just from a business fundamental standpoint, nor is it an inflation hedge. So we don’t really see a lot of conversation around this point as much anymore because of reasons like this and some big macro trends.
Jeffrey Snyder, Broadcast Retirement Network
And if I could just follow up on that, in terms of whether or not a planned sponsor, a fiduciary, wants to include this, has it traditionally been in the investment line of itself? So you’ve got large cap growth, you’ve got international, all these different asset classes. Has it been there or has it been in things like target date funds or managed portfolios that maybe are still under your purview as the advisor, but maybe bifurcated away from the actual participant?
Edward McIlveen, CFA, Francis Investment Council, LLC
Yes. And so to that end, when you’re talking about specifically direct real estate, you have seen instances where products have been made available at a very broad, high level, where participants can’t necessarily trade on a daily basis, but planned sponsors can put it in as part of a model portfolio. The problem here has been around liquidity.
And going back to my comments earlier about how Amazon really took out a lot of liquidity within the mall space, we started to see that in COVID as well. And so the great problem, if you will, with direct real estate is liquidity. And that’s one of the things I just really want to make sure that we talk about because, gosh, yes, you can look at some of these long-term returns and income streams that are coming from direct real estate, but you have a huge liquidity problem.
And there’s so many funds that have been gated that if you do want to make an asset allocation change in your model portfolios, it becomes extremely difficult to do that.
Jeffrey Snyder, Broadcast Retirement Network
So if I may follow up on that as well, let’s talk about liquidity. By that, I believe you mean, and I want to get you to clarify, that mutual fund trades every day and NAV is stricken after the market closes or created, and you are able to trade in and out of that fund at least once a day with a traditional mutual fund or an ETF multiple times a day. Are you saying that with these direct real estate products, you’re not typically able to sell out of them on demand?
Edward McIlveen, CFA, Francis Investment Council, LLC
That’s correct. In fact, what has historically been held out as a selling point for liquidity was, hey, we can make some adjustments on a quarterly basis. Well, then those adjustments started to get fewer and fewer, and the clamps really started to come down.
And when you think about gates, what was held out as being quarterly, and if you wanted to start making adjustments to unwind a position entirely, this is something that is just not feasible in certain cases. So what is held out as being quarterly liquidity is really just for a very small amount of fractional changes in asset allocation versus a mutual fund, of course, where you can go ahead and make a daily trade as you wish.
Jeffrey Snyder, Broadcast Retirement Network
So it sounds like this is a potential challenge. Anything built by man can be overcome. It sounds like this is a challenge though.
If you’re a fiduciary, you’re in those meetings. You’re certainly in those meetings on at least a quarterly basis. You’re thinking about adding real estate either as a REIT directly to the lineup or direct real estate.
It sounds like this is kind of a challenge that needs to be overcome, or at least thought through from the fiduciary perspective.
Edward McIlveen, CFA, Francis Investment Council, LLC
Yeah, absolutely. And just thinking about some of the other kinds of assets that are being contemplated in the private equity, the private credit, private real estate world, as the guidance comes out around that, well, these asset classes are held out as being great return and diversifiers, return enhancers and diversifiers, but what about liquidity? And that is something that we have really yet to see get solved.
And I think you’ve already had kind of an initial dry run at what the liquidity problems can look like in a private world with regards to direct real estate and something that from whether it was a defined benefit pension plan or even as part of a defined contribution plan, if there are products that are available and there are, then you are not able to act on a liquid basis like you would with anything else. And this becomes very difficult to sell to your participant base that believes that, yes, I’ve got access to my funds.
I’ve got control over that. This is now one of the vectors, if you will, of liquidity that really is not what I think most people are expecting either at the committee or the participant level.
Jeffrey Snyder, Broadcast Retirement Network
And you mentioned participant education. I mean, this is something that your firm in particular specializes in. It’s that being able to, you know, you may be an expert in the field that you’re in, meaning the participant, they may be an expert in manufacturing or whatever, what have you, but they’re not necessarily, these are concepts that may be a little bit more challenging to understand.
Edward McIlveen, CFA, Francis Investment Council, LLC
For sure. And when we sit down with participants to talk to them about what they own and why they own it, the more transparent that it is, the more simple it is, that is based on a long-term time horizon that has liquidity built into it for any investor that is saving for retirement. We’re building portfolios for 10, 20, 30, and 40 years.
This always has to fall under the banner of what we like to call simple, clear advice. And as soon as you start introducing liquidity provisions and liquidity gates, well, then all of a sudden that simplicity starts to evaporate pretty quickly.
Jeffrey Snyder, Broadcast Retirement Network
Yeah. It makes it kind of onerous the more rules there are. There are already a lot of rules around these plans.
The more rules they are, the more barriers there are to kind of entry. And it is like, I don’t want to deal with that. I personally don’t like a lot of rules.
So I’m like, okay, well, I maybe want to put that aside. Last kind of topic I want to kind of talk with you and we’ll have to bring you back. Let’s talk about the due diligence process because your firm does a lot of due diligence on investment products.
Is it analogous to what we do on the mutual fund and ETF and separate account and collective investment trust side, or are looking at these types of investments different in terms of that due diligence?
Edward McIlveen, CFA, Francis Investment Council, LLC
Yeah. The main difference with this is that from a security evaluation standpoint, we really like to just hear about the individual stories. And when I talk about the individual stories, if we’re sitting down and speaking with an investment manager that owns Microsoft or NVIDIA, we’re really interested in just understanding what is their long-term thesis and what have they believed previously to that?
Do things make sense as you hit certain mile markers along the way? With the direct real estate and with REITs as well, talking about some individual companies and holdings, this is a different level of due diligence because you get into areas of asset management. You get into areas of debt and how is that managed?
And when you’re looking at all of the terms and conditions that can float around some of these direct and private assets, it becomes quite onerous around that. The amount of time is significant. And so from an organizational standpoint, how do all these synergies come together?
The only way that we believe that you can do this effectively is by being onsite. And maybe that sounds like no kidding, but within this industry, there are a lot of people that do not do things onsite. They’re happy to just look at pitch books, they’re happy just to look at some RFPs, but you got to sit down and talk to the people.
And you got to sit down and understand why do you own what you own? And what is your historical perspective around this? Because no one’s got the crystal ball, but if we can get some aspects of, all right, how sustainable is the investment process in the past in generating the results that were generated?
Well, what can we look at five years, 10 years into the future? Again, nobody’s got that crystal ball, but for us, it is really just understanding the people that are operating that investment strategy and understanding what they think in terms of the individual holdings. And I would just also add to this, it’s not just a one and done type of interaction.
We like to build an institutional library around this, whether again, that’s talking to an equity manager or a direct real estate manager. All right, we’ve talked about this property five years ago, 10 years ago, how have things changed? What are the things that we’re always looking for things on the margin that would give us a clue as to the consistency of the process?
And if it starts to get violated, well, then you can imagine that’s where we start to get a little bit more cautious. All that said, this is an asset class for as well-spoken as some of these organizations can be, can tell you that if they have an issue with liquidity that is completely out of their control, well, then this is something that from a holistic standpoint, that’s just not something that we can continue working with because it’s completely out of their control. And they can tell us a lot about the individual buildings and the great thesis story for it.
But if you don’t have liquidity, well, then you really don’t have a thesis to begin with as well.
Jeffrey Snyder, Broadcast Retirement Network
Well, it sounds like, I mean, you have to, I got to close the show, but I’ll just end with, it sounds like, you know, you’ve got to, your firm has that particular area of expertise to look at these kinds of unique asset classes. You’ve got to really dig in. You’ve got to look at it.
It might be a little bit different than doing the traditional due diligence that most advisors do. Ed, we’re going to have to leave it there. Thanks so much for joining us.
And we look forward to having you back on the program again very soon, sir.
Edward McIlveen, CFA, Francis Investment Council, LLC
I appreciate it, Jeff. Thank you so much for the time.