General Systems Risk Management and A-REIT entity performance

Simon Huston, Clive Warren, Peter Elliott

Purpose

To investigate General Systems Theory (GST) risk management framework.

Academic traditions

Efficient Market Hypothesis Technical analysisFundamental

Quantitative (financial statements)Qualitative Practice Barra Risk Factor Analysis of

industry risk, investment themes and entity-specific risk (earnings growth, share turnover and debt rating)

Australian context

Dual economy mining boom - since 2004 80 % export growth 10 % foreign students Xrate destruction of manufacturing Population surge 1.6m (8%) in 5 year (new

dwellings = 155,000 pa) Concentrated in capital cities (80%) Affordability

3% homes affordable for poor households Ratio of house prices/ income = 4.6

Sources: PCA, COAG 2010, Rismark

Methodology

Develop GST RM modelBenchmark RM of A-REITs using public

Web-site info Calculate volatility-adjusted returns

(Treynor ratios). Asses link between RM score and

performance.

Stages

1. Develop GST-RM framework 2. Identify the major risks facing A-REIT 3. Benchmark stated risk mitigation practice in

key players Stockland Lend Lease Group Peet Ltd Mirvac Group AVJennings Ltd

4. Link with risk-adjusted performance

GST-RM model

Performance drivers

Strategic positioning Building portfolio

Product Location mix

Tenant covenant Management

Competitiveness Operational effectiveness

Supply chain optimization Strategic alliances

Responsiveness to turbulence Critical capabilities

Leadership and iintegrity Governance (agency problem) Core competencies

Project management Planning insight Environmental management Market surveillance

M. Porter (1996), “What is Strategy”, Harvard

Business Review (Nov-Dec), pp 61-78.

Major risks

Market Global

Toxic asset contagion Commodity prices slump

National Housing bubble? Immigration curbs Foreign investment restrictions Interest rate increase

Urban Infrastructure planning (Sydney metro) Planning bottleneck

Entity Strategic positioning

Major client defaults Operational effectiveness

Board underperformance/imbalance Financial statements

Banks withdraw financial support

Assets Unbalanced location portfolio Unsuitable product mix

RM scores

Stockland 8Lend Lease Group 6Peet Limited 5Mirvac Group 8AVJennings Limited5

Risk maps

Stockland RM profi le

0

0.5

1

1.5

2Strategic innovation

Surveillance

Capability

Controls Series1

LendLease RM profi le

0

0.5

1

1.5

2Strategic innovation

Surveillance

Capability

Controls Series1

Treynor ratio

mesure de la rentabilité par rapport au risque engagé

T = (ki – rf/ β

Excess returns wrt market ("alpha“) or risk free asset

β = Beta or relative volatility of asset

= Cov (i, m)/Var m

Caution: high TR can mean an asset with negative returns and a negative (counter-cyclical) beta

Risk adjusted performance

Stockland 21.3Lend Lease 7.08Peet Group Limited 29.35Mirvac Group 20.58AVJennings Limited17.48

Comparing best with worst

Lend Lease Peet Ltd

Findings

The GST framework directs attention to risks involving surveillance flexibility capacity controls.

No link (correlation) between publically assessed RM and volatility-moderated returns.

Implications

Displayed RM not sufficient condition for corporate success.

Display of inadequate RM could signal internal deficiencies?

Limitations

Web-sourced corporate information inadequate to properly score RM.

EMH predicts no publically-derived information advantage

Stock prices capitalise quality to maintain a consistent marginal price of risk.