Nick Thomas

Lonsec Research Releases Australian Listed Property Securities Sector Review

Australian Real Estate Investment Trusts (A-REITs) have failed to attract the same level of investor interest as other asset classes, despite a run of outperformance that stands in stark contrast to recent negative returns from Australian and global shares. According to the latest Australian Listed Property Securities Sector Review, published by Lonsec Research, A-REITs returned an average of 11.4% over the year to March 2016, and 15.8% over a five-year period. However, while returns have been strong, net flows across the sector have been weak, which may point to a lack of interest from investors.

“You might normally expect that when an asset class performs as strongly as the A-REIT sector has done over the past few years, retail investors would sit up and take notice,” said Nick Thomas, Senior Analyst at Lonsec Research. “However, with one or two exceptions, any pick up in fund flows has been conspicuous only in its absence. Looking at A-REITs within our active peer group, half of them experienced negative net fund flows in the year to December 2015.”

A-REITs are a standout asset class, but where is the money?

Over the 12 months to March 2016, A-REITs returned 11.4% on average, compared to 4.5% from Global Bonds, and 3.8% from Global Listed Infrastructure. Equities were in negative territory, with Global Equities returning -3.3% and Australian Equities -9.3%. A-REIT returns over 3- and 5-year periods have similarly outperformed, however, over 10 years returns remain affected by the global financial crisis (GFC), which saw the S&P ASX 300 A-REIT Accumulation Index fall 72.2% from its high in 2008 to its low in 2009.

The reasons behind the current lack of interest in actively managed A-REITs could be a desire for global listed property exposure, or a preference for more passive investment styles. However, Thomas believes that investor wariness of the listed property sector following the GFC could still be a substantial factor.

“The GFC may be in the past, but a lot of investors haven’t forgotten the pain of capital losses from a sector they expected to be more defensive,” said Thomas. “On one level, you can understand why investors may still be cautious, but on the other hand they may have missed structural improvements within the sector since this time. In the past few years A-REITs have proved to be a solid asset class that has been a beneficiary of the low interest rate environment, even through the general market volatility of 2015-16.”

Active managers deliver in tough markets

According to Lonsec Research’s analysis, in the period following the GFC, active A-REIT managers were able to achieve significant excess returns relative to the benchmark, highlighting the ability of the sector to provide outperformance when it is needed most. With the sector accumulating strongly since 2014, these excess returns are harder to find, and active managers have begun to fall below the benchmark. However, according to Lonsec Research, A-REIT managers have shown an ability to add value over the market cycle, which could prove valuable when current conditions change.

“What we have seen is that, immediately after the GFC hit, active A-REIT managers were able to take advantage of a sector that had been all but deserted by the market,” said Thomas. “However, with the bull market continuing into 2016, valuations in the sector have started to look stretched, and it has become more difficult for active managers to find value. But when market conditions change, that’s when an active strategy should begin adding value once again.”

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According to the latest review of small companies by leading research house Lonsec, the plunging value of resource companies has had a positive impact on the structure of the small cap market, despite being the major reason the sector has underperformed during recent years.

As the value of resource stocks fall, so too does their weighting within the index, Lonsec analyst Nick Thomas said. “This is leading to a healthier balance of companies and industries within the popular sector,” Mr Thomas said.

“The poor performance of resources has become a well-worn theme for small caps, persisting for the past four years. More recently, the main drags within the sector have been iron ore, gold and energy companies, this has also flowed through to put pressure on companies within the mining services sector,” he said.

During 2014, The ASX S&P Small Ordinaries index recorded a 3.8 per cent fall, however, this was dominated by a 28.4 per cent plunge by small resources companies, which wiped out a 2.8 percent gain by small industrials.

Funds rated within the Lonsec small cap peer group, however, had already shown a strong bias away from resource companies last year. According to its latest review of the small companies fund sector, Lonsec-rated managers outperformed the market on average by 6 percentage points to produce a 2.2 per cent gain after fees, compared with the index 3.8 per cent loss.

“Fund managers who have shown strong industrial stock selection, as well as avoiding the blow ups in mining and mining services, have produced solid returns during the past three years,’’ Mr Thomas said.

The reweighting of the index as resource stocks fall from grace is also having a more positive impact on the wider small cap market sector.

“The obvious impact from the disparity between resources and industrials is that the materials and energy sectors now make up a far smaller proportion of the benchmark index,” Mr Thomas said. “They have been replaced by increases in consumer discretionary stocks, financials and, to some extent, healthcare and telecommunications.

“The number of new public offerings in the past two years has also helped this trend. Overall the balance and diversity within the index now looks far healthier,’’ he said.

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