Custom indices are gaining ground in Asia, with Korea's National Pension Service being the most recent example of an asset owner seeking to tie investment to a bespoke index targeting specialty real estate.
The world's third-largest pension fund announced on May 2 the creation of the FTSE EPRA Nareit Developed Extended Opportunities RIC 6/45 Capped Index’ -- a property-focused index in collaboration with the FTSE Russell to enable exposure to listed, non-traditional real estate sectors.
The W939.1 trillion ($710 billion) fund will allocate $1 billion in assets tied to the index.
While traditional real estate sectors comprise typically office and retail assets, NPS' bespoke index selects real estate investment trusts (REITs) and non-REITs that include more niche real estate sectors.
The new index includes exposure to niche real estate sectors such as data centers, self-storage, senior housing and student housing.
All of these sectors are experiencing higher demand from changing demographics or consumer patterns.
“Core properties have historically formed the basis of a REIT and the associated REIT indexes. ‘Office’ and ‘retail’ have been regarded as the core real estate sectors by institutional investors due to their long and stable performance track record. But that is changing with technology disruptions today,” Henry Ching, head of private markets in Asia at Mercer, told AsianInvestor.
“This new index has likely expanded the definition of what a REIT typically means by increasing the emphasis on income and portfolio construction and diversification. It has also incorporated additional factors important to real estate performance, such as tenant profile,” Ching said.
He pointed out that more factors can potentially lead to higher complexity and the need for greater rebalancing of the index.
NPS did not respond to AsianInvestor’s queries for more details related to the index.
Custom indices are a relatively new phenomenon but gaining popularity in asset owners as they become more sophisticated.
Bespoke indexing helps institutional investors customise a portfolio based entirely on their investment goals and preferences.
Investors can decide the methodology of these bespoke indices, which can be adjusted when required.
This flexibility is possible because custom indices often are implemented through separate accounts, in which investors own a custom mix of individual stocks and bonds rather than indirectly owning positions through a collection of exchange-traded funds.
It indicates the investor is keen to adopt an active approach even within a passives strategy.
While NPS took an active role in co-creating the index, it will be open to other investors as well.
The index includes 70 constituents across ten countries including Australia, Belgium, Canada, Singapore, the United States, and the United Kingdom,
Emerald Yau, head of equity index product management in Asia Pacific, at FTSE Russell, said there is a difference between asset owners requiring small modifications on standard indices and entirely “custom-made” indices, such as what NPS created.
The index provider often gets requests on “small tweaks” – such as select countries, select sectors and different factor target – that is mostly a matter of carving these categories out from existing standard indices.
These requests usually come from passive managers who need to manage portfolios with specific parameters, and their considerations are often related to ease of operations and trading costs.
“In the custom index space, we work with clients who may have specific input into the methodology or would like to have the ability to modify the parameters – like number of constituents and select countries – from time to time. In such cases, we would cater a customised index to offer flexibility to the client,” Yau told AsianInvestor.
Customisation requests are particularly high in the sustainable investment space, she added.
However, there is a lack of coordinated regulations or global approach as countries have different standards and regulations on sustainability.
“One common customisation needed on sustainable indices is, therefore, to incorporate the clients’ own exclusion lists, based on their own interpretation of which companies violate such standards and/or regulation and need to be excluded from respective sustainability portfolios,” Yau said.