By Christopher M. Wright

Portfolio recently talked to two key players with a focus on indexing who are helping to shape the global REIT market. Mark Makepeace is chief executive of index provider FTSE Group, and Amy Schioldager is a managing director at Barclays Global Investors (BGI), which is preparing to launch two funds based on global real estate indexes.

Mark Makepeace Chief Executive, FTSE Group Industry Experience: Makepeace began his career at the London Stock Exchange where he worked on the deregulation of London's equity markets (the "Big Bang"). He became head of LSE's Index Unit in 1990. He has been chief executive of the FTSE Group, jointly owned by the Financial Times of London and the London Stock Exchange, since the unit became autonomous in 1995. UNICEF has awarded him an honorary fellowship in recognition of his significant fundraising activities on its behalf.

M A R K    M A K E P E A C E

The FTSE Group, a leader in the design and management of stock market indices worldwide (including the ubiquitous FTSE 100 for U.K. stocks), assumed responsibility for calculating the FTSE EPRA/NAREIT Global Real Estate Index series in February 2005. The series, which covers 274 stocks in 28 countries, is divided into three families (Europe, Asia Pacific and North America) and includes 43 subindices, 12 in real-time. Portfolio recently asked FTSE chief executive Mark Makepeace about the impact of indexing on global real estate and what his company is doing to raise the profile of the FTSE EPRA/NAREIT series among investors worldwide.

Portfolio: What did FTSE see in the FTSE EPRA/NAREIT Global Index that made you want to take it over?
Makepeace: First, I suppose, was interest from investors. We always try and go to the end user, the investor, not just the people who create products. What we could see was clear demand from investors worldwide for these indices, so we saw the potential. Also, real estate is an asset group for which we hadn't previously sought to provide an index, so it seemed a natural fit to us, and there was clearly a lot of interest around the world.

Portfolio: What changes did you make to the EPRA/NAREIT methodology when you took over the index? What are the benefits for investors?
Makepeace: The first big thing we did was to extend the coverage to Asia-Pacific and turn it real-time, so we were able to introduce a global 24/7 real-time calculation. We also improved the quality of the service that was going to the clients. Because we have offices around the world, we were able to talk to people directly, understand their needs, and respond. You get local support wherever you are around the world at the time you need it and that adds value to the series. You've certainly seen quite a dramatic increase in sales and usage because of the way we've responded to individual clients. The indices have a much higher profile now.

Portfolio: What are the prospects for expanding the numbers of subindices in real time?
Makepeace: We're very flexible. We will respond to user demand. If there's demand for that, we'll bring them on as real-time indices. In fact, we've already had a large number of requests for new subindices and we're working through the priorities now to decide which ones are the most important. We also do custom indices for individual clients in real-time or end-of-day calculations.

Portfolio: What is the potential you see for this series?
Makepeace: There's a lot of potential in terms of exchange-traded funds [ETFs] and index funds. The indices are fast getting recognition as the standard for this market worldwide. The potential for the use of the indices matches the way the industry is growing, and it's growing very fast at the moment. We've already seen one series of ETFs by AXA. There are other ETF issuers who are going to launch products pretty soon in Europe and America and you'll see that usage continuing to grow.

Portfolio: Who else has licensed the FTSE EPRA/NAREIT series and for what purpose?
Makepeace: First of all, there are quite a large number of users who are issuing warrants, certificates, a whole range of products linked to these indices. AXA continues to introduce regional ETFs based on the series. Then what you're going to see in fall 2005 are further ETFs by at least one other issuer in Europe and, subject to SEC approval, we hope to see the first ETF in the U.S. by the end of the year.

Portfolio: What do you expect to happen in the future with respect to tradable funds and other licensing activity?
Makepeace: We're already starting to see a number of over-the-counter (OTC) derivative products [futures and options], and I think we're going to see more and more of those. Once there's sufficient usage in that way, then we would hope to see some trading on a derivatives exchange in the U.S. or Europe. We need the index series to have a longer period of time with more products launched on it before exchange-traded products would have enough liquidity. That's a year or two away.

Portfolio: Do you have any plans for a global index composed entirely of REITs and other REIT-like structures?
Makepeace: That would just be another subset and we've had one or two requests. We'll do that if there's sufficient demand, but there are other priorities ahead of it.

FTSE EPRA/NAREIT Global Real Estate Index Returns Year to date in U.S. Dollars as of Oct. 4, 2005

Source: FTSE EPRA/NAREIT Global Real Estate Index

Portfolio: How does the FTSE EPRA/NAREIT series stack up against competitors?
Makepeace: We are the only global real-time real estate series but, beyond that, the difference between our series and others is that the real estate industry determines what companies should be included in our indices and what subindices are needed. EPRA and NAREIT manage the advisory committees for the series, so the industry is very much involved. Because of that, we're able to reflect what is happening in the industry better and quicker than anybody else. I think that's what helps make our indices the standard. The combination of industry involvement and FTSE's client service is unique. I don't think anybody else can achieve that.

Portfolio: FTSE indices are particularly popular with U.K. investors, but marketing efforts are underway to increase your market share in the U.S. What efforts are you making to build investor acceptance for the FTSE EPRA/NAREIT series in the U.S. and globally?
Makepeace: We are the biggest, most successful index provider in the world outside the U.S. The U.S. is our target market for growth. We already have important clients like CalPERS, but you will see a higher profile in terms of our name and indices amongst all the data vendors—Bloomberg, Reuters—and on the media channels like CNBC and Bloomberg TV.

We have marketing publications that have featured the FTSE EPRA/NAREIT series which go regularly to the desks of the biggest institutional investors worldwide. We have a circulation of about 20,000. So we have both targeted and mass-marketing activities that go on around the world. If people haven't heard of the FTSE EPRA/NAREIT series in a relatively short period of time, I'll be very surprised.

IMPACT OF GLOBAL INDEXING

Portfolio: What is the impact of indexing on the global real estate sector? Makepeace: It should attract more funds to real estate. It provides more options. The whole idea of indexing in real estate is to provide a lower cost vehicle for investors. Schioldager: If a lot of index funds begin to manage money against global real estate, you would expect to see increased liquidity in the market, more buying and selling of individual stocks by these funds every day, and that would be a good thing. Portfolio: What are the primary benefits of global real estate indexing? Schioldager: Really the same two primary benefits you see in any index product. The first is diversification because indexing gives investors broad-based exposure to that segment of the market. In addition to that, low cost—indexing products generally come in at lower cost compared to actively managed portfolios. Makepeace: The benefits of going global are about diversification. You can diversify away from just the U.S. and that's a real benefit, but you clearly have to have an understanding of what you're doing and access to experienced advice. Portfolio: Amy, what is your view of the FTSE EPRA/NAREIT Global Index? Is it a suitable index upon which to base an investable global real estate fund? Schioldager: I definitely like the FTSE EPRA/NAREIT Global Real Estate Index. It's a good solid index. It has good methodology, and I would say absolutely it's suitable for both retail and institutional investors. Portfolio: How hungry are investors for global diversification in real estate? Schioldager: We're not seeing the demand currently but do expect demand to increase. Examples like the ING closed-end fund offering which raised about $1.5 billion suggest demand is getting stronger. Portfolio: Do you expect the real estate industry to expand even more globally? Makepeace: I think that's almost certain. You're seeing REIT structures being created by governments around the world. The question at the moment is whether the sector will expand fast enough to keep up with demand. Schioldager: There are many countries that have proposed or begun implementing legislation for REIT-like structures. That's likely to increase the number of real estate securities available which is great for indexers because we want truly diversified portfolios. The more securities that are available, the better product you have. Portfolio: FTSE has an office in Beijing. Will we see a REIT-like structure in China and, if so, when? Makepeace: FTSE does a lot of work in China and it's a market that's been growing very fast. My view on China is that they will eventually develop a REIT-equivalent but the problem with China is that these things take time and there's always a lot of uncertainty.

Amy Schioldager Managing Director, U.S. Equity Index Department Barclays Global Investors (BGI) Industry Experience: Schioldager started in fund accounting at BGI in 1989. She moved to international equity portfolio management and became manager of that group in 1995. She has been in her current position since 2001.

A M Y    S C H I O L D A G E R

Barclays Global Investors (BGI) is the largest U.S. REIT manager with nearly $7 billion in REIT assets. BGI is also one of the largest asset managers in the world overall, managing more than $1.3 trillion of assets on behalf of clients in 48 countries, including two-thirds of the world's largest pension plans. BGI created the first index strategy in 1971 and now offers more than 120 iShares® exchange-traded funds [ETFs].

Managing Director Amy Schioldager is spearheading the firm's foray into global real estate indexing. Portfolio recently talked to her about those efforts and where she thinks the global real estate market is headed.

Portfolio: When and why did BGI first begin investing in REITs?
Schioldager: BGI started its first collective fund over five years ago. That was due to client demand and a maturing REIT market. There had been increased liquidity in the REIT marketplace starting in the late 1990s and then a reaction to the technology bubble, where people were looking for bricks-and-mortar again.

Portfolio: According to a BGI April 2005 report on real estate, "With increased acceptance by investors, their diversity advantages, breadth and liquidity, and recent strong performance, REITs are becoming an essential part of the institutional portfolio." What role do you see REITs playing in institutional portfolios over the next two years?
Schioldager: A lot of institutional clients such as large corporate and public pension plans buy direct real estate but in many cases are underweighted in their strategic real estate asset allocations.

REITs play a very pivotal role in filling those allocations for large clients as a complement to direct real estate. For small to mid-size institutions adding a real estate allocation, it's unlikely that direct real estate makes sense given the amount of time and personnel required to build a diversified property portfolio. So for those clients, REITs make perfect sense as a substitute for direct real estate.

Portfolio: BGI offers two domestic real estate ETFs—ICF (based on the Cohen & Steers Realty Majors Index) and IYR (representing the Dow Jones Real Estate Index). The top holdings for these two funds overlap quite a bit. Why offer both?
Schioldager: Cohen & Steers is more of a large-cap fund—there are only 30 stocks. As for IYR, it has broader, more diversified exposure to REITs with approximately 80 securities.

Portfolio: Why would an investor choose one over the other?
Schioldager: It depends on what kind of investor you are. If you're a hedge fund doing sector plays—taking long positions in the health care sector and shorting the financial sector, for example—the Dow Jones REIT fund completes the full suite of sector products. If you're a retail investor looking for REIT exposure, the Cohen & Steers fund tends to be a better product.

Portfolio: Which is best for investors seeking exposure to U.S. REITs that are expanding internationally?
Schioldager: In general, the large-cap stocks are the ones going global first, which makes sense since they have more capital and have built up a certain amount of dominance in the U.S. so the desire for further expansion causes them to go global. You see that with companies like ProLogis (NYSE: PLD), AMB Property Corporation (NYSE: AMB) and some others. [BGI holds ProLogis and AMB in various ETFs and other funds.] The Cohen & Steers fund, because it's dominated by large-cap stocks, would tend to have more of an international element to it.

Portfolio: How does global real estate fit into your company's strategy as the largest REIT manager in the U.S.?
Schioldager: Active portfolio managers [who devote substantial resources to security selection] have higher fees and it's much harder for them to provide investors with a competitive return after fees. There are people who can outperform in active management space, but you have to have some skill in choosing the appropriate active manager.

Instead, we have a quantitative [passive and enhanced indexing] philosophy. We give investors diversified exposure to different segments of the market and global real estate fits in well with the philosophy. There are enough companies in the global real estate space that we can provide investors with a diversified portfolio.

Portfolio: BGI told us in 2004 that it was looking at the possibility of launching a global real estate index product. Where do things stand?
Schioldager: We plan to file more real estate products with the SEC to expand our product offering in the near future. We have heard demand exists for both broad and narrow segments within the real estate sector.

We haven't seen quite the demand we'd like to see in this space. But global real estate makes sense, and we've seen situations before where institutions first invested in some segment of domestic equities or bonds and later added an international allocation to their portfolio. The U.S. REIT market has become quite mature over the last 10 years in terms of liquidity and the number of REITs available. It's a natural extension for investors to look to global real estate exposure, but I don't think that view has yet percolated down to all investors.

Portfolio: What is your company's view of enhanced indexing (hybrid funds that seek to modestly outperform indexes, e.g., by avoiding obvious losers) and is there room for enhanced indexing in global real estate investing?
Schioldager: Enhanced indexing is something BGI does day in and day out. We're very successful in that arena. Our initial focus on global REITs, however, will be with our index products.

Portfolio: Putting on your portfolio manager hat for a moment, what's the appropriate allocation to REITs and global real estate?
Schioldager: Real estate should be 5 percent to 10 percent of the equity portfolio. Optimization models tell you to buy more, as much as 20 percent, because of the low correlation between REITs and other stocks and bonds, but I would not advocate that. We see most institutional investors in the 5 percent to 10 percent range and that's also appropriate for the retail investor. Part of it should be in the U.S. and part of it in the global space.