Q:  What is the history of the company and the fund? A : Invesco Real Estate has been investing in commercial real estate for institutional investors since 1983. The firm oversees over $50 billion in real estate investments around the globe. The Invesco Global Real Estate Income Fund was launched in 2002 and now has $1 billion under management. The fund invests in commercial real estate companies and related commercial real estate fixed income securities. Unlike traditional real estate funds, we not only invest in Real Estate Investment Trusts (REITs) but also in debt securities that are linked to real estate. Since the financial crisis of 2007 and 2008, we realized that there are inefficiencies between equities and fixed income tied to commercial real estate. We strive to provide equity-like returns with less volatility and a higher yield profile. In commercial real estate investing there are certain risk-adjusted opportunities when you have the capability to move within the capital structure between debt and equity. In 2011, we expanded the fund’s investment mandate from only domestic to global real estate securities to take advantage of the economic growth in other parts of the world and for the relatively attractive income stream that can be found outside U.S. markets. Q:  What are the advantages of relative value based investment strategy? A : Over the last three to four years, the volatility of the capital markets has led to certain periods when equities are in favor and other times fixed income. This fund is particularly well positioned for the current environment because we look across the entire capital structure in the real estate sector including both equity and debt. On a daily basis, we are making a risk-adjusted return assessment of what is available in the marketplace. As an example, when the market gets potentially too positive about the equity side of the equation, diminishing the potential for additional gains, we move into fixed income. The fund is designed to take advantage of relative values in the sector by investing in any part of the capital structure and providing a relatively lower volatility profile. This is the type of daily rebalancing that an individual cannot easily perform without certain resources and expertise. We have a unique capability in that we are in essence “local” investors because we have a large professional real estate staff in 17 offices around the globe. We are in so many markets because real estate requires an on the ground knowledge of property valuations and risks. Additionally, you also have to be able to assess investments across markets to identify the best relative value opportunities. Q:  What is your investment philosophy? A : Long term we are looking for a return that is consistent with owning a broadly diversified portfolio of real estate equities with less volatility. Our goal is not necessarily to achieve the highest returns, but we seek to deliver more consistent and less volatile returns with a higher dividend yield than an all equity portfolio. Our investment process is a three-step process. The first step is the allocation decision of equity versus debt. This decision drives the performance as it relates to lower-volatility type returns. When we are looking at allocating between equity and debt, there are multiple inputs that go into that decision. Two important factors include expectations on economic growth and expectations of real estate fundamentals as they relate to occupancy improvements, cash flow growth, and other property metrics we track. Another factor is the pricing in the real estate equity and debt markets. We regularly evaluate return expectations implied by the markets to evaluate whether there is sufficient reward for accepting the additional volatility normally associated with equity investing, and if this is not present, we normally tend to emphasize debt over equity. Conversely, when the market is overly pessimistic regarding property growth expectations and there is a return premium associated with taking additional risk, we tend to increase our exposure to real estate equity. The second step is our security selection process. Within our equity and debt allocations, we want to make sure we are getting the best securities for the best price. We view ourselves as a fundamental real estate manager and consequently have a bottom-up security selection process. For both equity and debt investments, this process is driven by real estate underwriting and fundamental expectations. Through this process, we underwrite the underlying assets of a portfolio and analyze the capital structure or balance sheet risk. We then decide on what are the best securities that provide the best risk-adjusted return within real estate. One of the ways we differ from a general fixed income manager that invests in real estate as a sector in a broader fund, is that we have a fundamental analysis process for both debt and equity. The goal of this is to ensure we are focused on the higher quality securities with better capital structures and better expectations for real estate growth. Our collateral underwriting includes the understanding of individual office buildings, malls, warehouses, and apartments, as well as the markets in which they are located. This is something that a general fixed income manger may not have the ability to do. The third step is focused on portfolio construction. This part of the process is to ensure that the securities selection process is not skewing the portfolio from our overall allocation decision. We do also have certain metrics that we monitor from a risk perspective within the portfolio such as the duration of the debt holdings and allocations by region. Our focus throughout our investment process is not on a one-year return for the fund. We have a much longer-term real estate view and therefore are looking at rolling three to five year return expectations as relates to relative equity and debt pricing. Q:  What is your securities selection process? A : We have a bottom-up selection process. We focus on underwriting the underlying assets of companies to understand the impact on cash flows or asset valuations on the equity side, and how this translates to loss expectations for fixed income investments. Through this process we are seeking to provide outperformance from our specific security weights within the portfolio. The bottom-up security selection process also generally drives our over or underweights to specific property sectors or regions. Q:  What global themes are driving real estate markets? A : Real estate opportunities in the Asia-Pacific region are driven by infrastructure needs. For example, China is going through a rapid urbanization as people move from farmland to cities. These emerging consumers are creating demand for consumption of goods and services. Housing, retail, and logistics have to be built to support that shift. Although Japan is a developed market, we are still witnessing a migration of multinational and domestic tenants from older office buildings to newer construction that is seismically superior with better electric power support. The earthquake and tsunami that occurred in 2011 is still fresh on everybody’s mind and due to growing power shortages, backup power generation is a top tenant requirement. We also see continued migration into the central Tokyo area, creating more demand for housing and retail properties. Australia is a developed and balanced market with a modest growth outlook. Due to higher base interest rates, there is still relatively attractive yields, creating some interesting risk-adjusted investment opportunities. Across all property types in the U.S., there is a general rebound as a recovering economy combined with a lack of new real estate supply has created a positive fundamental environment. Broadly speaking, new construction should be far below tenant demands for the next several years driving occupancy rates higher and increasing rental rates. Canada provides fairly similar fundamentals to the U.S. but potentially more stable economic growth and slightly more attractive valuations. Additionally, the currency will be potentially stronger long-term relative to the U.S. dollar. Europe is likely a wait and see situation. We have a somewhat conservative view and have been rather cautious generally owning only the best companies with the better balance sheets in Europe. Although we would not say there are wholesale opportunities throughout Europe, certain fundamental opportunities do look attractive. For example, the U.K. based Collateralized Mortgage-Based Securities or CMBS provides much higher yield opportunities when compared to the U.S. and can be secured by ultra-premium locations of London office buildings. Q:  What is your investible universe? A : Our investible universe is about $2 trillion in size ranging from real estate equity and debt securities. A third of the market is eliminated through our fundamental ranking process focused on underlying real estate fundamentals, balance sheet strength, and management or borrower alignment. We are a diversified fund and focus heavily on risk control. We generally have between 150 and 200 different securities holdings, including common and preferred stock of Real Estate Investment Trusts or Real Estate Operating Companies, Commercial Mortgage-Backed Securities, and unsecured corporate debt. Q:  How are these securities divided across the globe? A : On the equity side, the universe is comprised of approximately 45% U.S. with the next largest being Hong Kong at 12%. Japan and Australia also have a large representation in the investable universe. On the real estate debt securities side, about 80% of the marketplace is in the U.S. Generally speaking, the U.S. fixed income market is much more mature and liquid, than other regions globally. Q:  What is your fundamental ranking process? A : At a high level, for either debt or equity, our fundamental analysis involves scoring all potential investments on a scale of one to 10. For us to be able to invest, the security has to score a five or above. If at any time an investment that we own falls below a five, it would be an automatic sell. In essence, we have our own quality rating for each security in the real estate universe. Our scoring is broken down into three segments. The first segment is focused on the real estate market. Our proprietary real estate research sets the expectations of growth at the property sector level based on supply and demand in specific markets around the world. This research produces what our expectations are for occupancy and for market rate growth in those areas. The second part of the process relates to the actual real estate assets that either a company or trust owns in those markets. As bottom-up real estate investors, we have expectations for our analysts to go and see these properties and to have their own opinion as to the position of those properties in the market. These two segments comprise 60% of our fundamental ranking score. Over the long term we believe that market and underlying property selection will drive the majority of performance. The remaining 40% is focused on balance sheets, management or borrower incentives, and overall investment transparency which will either be additive or dilutive to the real estate market exposures. Our process does have a quality bias. If you look at long-term real estate performance, it has been those companies that have had the best assets in the most desirable markets and better balance sheet that have outperformed. Q:  Can you give two examples to explain your research process? A : A UK based CMBS trust would be a good example to discuss from a debt perspective. In the UK, CMBS is generally secured by two to three properties, located centrally around London, which can be backed by only one borrower. These are relatively small pools, which gives us the capability to actually underwrite the underlying property cash flows and make a judgment on current and potential future asset values. This process can be different from a more general fixed income manager who may look at that same London office CMBS trust and possibly view the concentration risk as too high or be unable to underwrite the specific assets. We actually prefer these smaller pools because we can gain a better understanding of the collateral. Our real estate expertise and knowledge of specific markets and assets allows us to concentrate on those investments that we believe can outperform. Through the underwriting process, we are making our own assumptions through market knowledge on what underlying market rents are for these properties, what are expectations for stabilized occupancy levels, what are average expenses, and where we believe that property should be valued. This then translates to a determination of true loan-to-value and debt service coverage at the loan level. Once we have an understanding of how the structure is levered and what is the valuation of the property versus the debt, we then can make a decision on where we want to be in the capital structure of that CMBS transaction. This risk-adjusted decision is driven by yield or total return expectations versus the potential for loss. From an equity standpoint, Ventas REIT Inc is another good example of our applied research discipline. Ventas is a healthcare related company that has a healthy balance sheet with a long management track record. Recently, Ventas issued a fixed income security in the form of preferred stock that was priced at a yield 300 basis points higher than where the unsecured corporate debt was trading. After analyzing the total amount of leverage including the new preferred stock, the additional risk added to their balance sheet was not, in our view, significant enough to warrant such a large pricing difference to the outstanding unsecured debt. By investing in both equity and debt, we are able to find securities that we feel, from a relative value perspective, are underpriced compared to the rest of the capital structure. Q:  What drives your portfolio construction process? A : Our overall goal is to provide the best risk-adjusted real estate returns and also provide an attractive stream of income. We do not necessarily tie ourselves to one benchmark and can often deviate quite considerably from the more traditional all-equity indices, such as FTSE EPRA/NARIET, because of our assessment of relative value opportunities. Over the long-term, we have been able to produce total returns in-line with those equity benchmarks with less volatility, although in any one specific year this performance can deviate such as was the case in 2012. By analyzing real estate equity versus debt opportunities, we continue to believe that we can provide those competitive returns. Q:  How do you define risk and what do you do to manage it? A : There are two ways we define risk. One is the volatility of the underlying securities and by extension, the fund. On this measure, our goal is to deliver a fund that produces equity market competitive returns with less volatility. During the ten year period since the fund started in 2002, the fund has delivered (with dividends reinvested) annualized performance in excess of 10% with approximately 30% less volatility than real estate equity benchmarks. The other definition of risk relates to investing in securities that may not be fundamentally strong. Our fundamental ranking of each security and excluding those that fall below our quality threshold of five on our rating scale, goes a long way toward managing fundamental risks in the portfolio. We work very hard to focus our efforts on owning the better securities within the commercial real estate universe. Our investment process is designed to efficiently and continually incorporate new and changing real estate, financial market, economic, company and other information into the investment decision making process. Our method of integrating fundamental and quantitative techniques enables us to assess and quantify the impact of changing economics and perceptions on securities pricing and relative value. By definition, many market changes are unforeseen; however, our investment methodology has a systematic process that allows us to incorporate market changes. In addition, it also allows us to test the potential portfolio impact of these market changes.