REITs: The active vs. passive debate

The debate is heating up as investor expectations rise and asset managers continue to try and reduce fees

REITs: The active vs. passive debate

With investor expectations rising and asset managers trying to reduce fees, the active versus passive debate is really heating up. Competition is intensifying as investors shift more assets into passive index-linked funds but with valuations looking increasingly stretched, are investors missing a trick by turning away from active managers?

“Any time you have a space where there is complexity or where there is benefit to having specialized knowledge, active management has an advantage,” says Dennis Mitchell, Senior Vice President and Senior Portfolio Manager for Sprott Asset Management.  “If you look at sectors like materials, mining and energy, there are clear advantages to understanding the geography, geology and the technology behind pulling hydrocarbons out of the ground.”

With equity markets looking challenged, more investors are gravitating towards REITs in search of returns. It’s an area in which Mitchell feels active management has some distinct advantages. “Real estate is an area that people think they understand intimately because they own a house and work in an office tower,” Mitchell. “But, really and truly, it’s a sector where investors generate better returns with active managers who have intimate knowledge of exactly how real estate is financed, developed and how it’s utilized by either consumers or people who work in the real estate.”

Mitchell gives the example of seniors housing to illustrate the importance of active management in REITs. He points to the commonly held misconception that seniors housing will continue to grow and generate strong returns on the back of people living longer and suffering more medical problems. However, if you drill down into the various subsectors of seniors housing it becomes evident that there are significant differences between long-term care, assisted living and independent living, which in turn creates diverging risks and returns for investors. In Canada, there is no limit to the amount of independent living and assisted living facilities that can be developed.

“So, despite the fact that the population is aging and people are requiring more specialized care, there is no limit to the amount of new supply that can be put on stream,” Mitchell says. “So, a lot of people investing in that space will be disappointed with the long-term returns. That’s very different from long-term care where a license is needed to operate a facility. That creates opportunity to constrain supply as demand increases and so the returns in that space may be a pleasant surprise for investors in the long-term.”

“I’m always going to say that active management should be able to add value, but that’s particularly true where there are sectors and sub-sectors where specialized knowledge can be provided.”

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