Liquidity Pricing in Unlisted Real Estate Funds

Abstract

Traded securities have been mainly used to study the two-way causality between returns and liquidity in the finance literature. We argue that this issue is even more important for unlisted funds, particularly if they invest in very illiquid assets. Using the investment performance of UK Real Estate open-ended unlisted funds, we also analyze the impact of managerial, economical and investor variables on the pricing of real estate mutual funds. Our empirical results show that, on one hand, illiquidity is attached to a higher expected return as investors are willing to pay a price for liquid assets and, on the other hand, higher returns attract more investors driving liquidity up. Particularly, we find that overall transaction volumes contain little information unless we separate between inflows and outflows. Furthermore, we find that returns are influenced by the direction of flows (either buying or selling side) and that fund types and some asset manager's characteristics are not significant and should then play a minor role in the investment decision process. Finally, through a montecarlo simulation we show a smart-money effect where using this set of information to build portfolios of funds may have a significant impact on the likelihood of overperforming the benchmark.