PFA says Portfolio Theory needs to be revised in relation to property exposure
The Property Funds Association (PFA) has released data that suggests that current portfolio allocation theory needs to be revised to better address the current volatile market.
In the current market, Retirees are becoming increasingly concerned with the substantial and sharp reduction in their capital base, which is primarily the result of exposure to highly liquid investments.
In a typical portfolio theory, the total allocation to property is 11% and of this allocation, 73% comprises listed property exposure[1]. Due to the close correlation of listed property to equities (currently about 0.7, whilst unlisted property is -0.2), PFA believes that portfolio theory may need to be revised so that listed property forms part of the equities allocation, and property allocation comprises predominantly unlisted, syndicated (or direct) property investments.
PFA President Robert Olde, said; “Despite the noise surrounding the property sector and funds that have incurred capital losses in recent years, Unlisted Property and Syndicates remain the strongest performing core asset class inAustralia over the last decade. They have outperformed the Australian equities market by 2.2%pa, but with much lower volatility. In fact, the volatility is closer to that that experienced by bond investors, providing further proof of the defensive nature of direct real estate investment.”
“On this basis, one must ask why the investment industry continues to back lowallocations to unlisted/direct property investments when it appears to be a superior asset class for long term superannuation investors, especially as the investments trade on fundamentals, not sentiment,” he said.
Mr Olde said data obtained from Mercer Investment Consulting’s performance surveys also supported a change in thinking in property allocations. “Results showed that as a defensive component of a portfolio, Unlisted Real Estate provides growth returns with defensive characteristics and Unlisted Property has provided the same Risk/Reward Contribution to a Portfolio than Australian Bonds but with significantly higher returns.”
Results from Mercer showed that over the 10 years to 30 June 2011:
- Cash returned 5.4% pa
- Australian Bonds returned 6.2%pa, with a 2.9%standard deviation (a risk-reward ratio of 2.1)
- Unlisted Property returned 9.4%pa, with a 4.4% standard deviation (a risk-reward ratio of 2.1)
- Australian Shares returned 7.2%pa, with a 13.3% standard deviation (a risk-reward ratio of 0.5)
- Australian REITs returned 2.2%pa, with a standard deviation of 17.6% (a risk-reward ratio of 0.125).
Mr Olde added, “The current allocations are also particularly interesting when you consider that High Net Worth and Ultra High Net Worth investors hold up to 35-50% of their portfolio in property[2]. Property is seen not only as a way to preserve wealth, but to also augment it and this is particularly relevant when you consider that property investment in most cases is an inflation hedge, given the structure of leasing arrangements. If the sophisticated investors are so heavily weighted to property, why is it that a similar approach is not adequate for the typical Australian retail investor?”
“Australian retail investors simply have too much exposure to listed markets and they should have higher allocations to unlisted real estate. Historic evidenceover both the short and long term indicates the benefits of having a portion of one’s portfolio allocated to unlisted real estate funds.”
Recent PFA research also shows that the totalreturns of direct property on an after-tax basis exceeded A-REIT returns over all examined periods. Tax, fees and other costs had a minimal impact on relative total returns from direct and listed property.
Cumulative returns of direct property and listed property over 25 years also showed direct property supplied higher returns than A-REIT’s, with substantially lower volatility due to the lower level of liquidity, which is inherent in real estate investment.
