Jonathan Baird

While the interest rate sensitivity of REITs has recently spiked, Jonathan Baird, Investment Analyst with Zenith Investment Partners, believes this is a relatively short-term trend and should not be relied upon for structural asset allocation decisions.

When discussing Zenith’s Property Sector Review released this week Baird said ‘The view that REITs have bond like characteristics may be partially derived from the income pass through that is supported by the trust tax structure. This structure generally results in higher dividend yields and payout ratios relative to broader equity markets. However, changing property valuations and fluctuating earnings streams have delivered varying correlations to the Australian bond market over the past ten years’.

Baird said “Generally, managers continue to view the sector as trading at fair value, with many believing current conditions are relatively conducive for active management”. The report also notes that many managers in both domestic and global REITs are anticipating a total return in the range of 7% to 9% for the next 12 months.

From an initial investment universe of 70 Property products 5 were rated “Highly Recommended”; 15 “Recommended”; and 9 were assigned an “Approved” rating. In addition to the investment grade ratings, 3 funds were placed on “Redeem”; 36 were “Not Rated”; while 2 strategies remain “Under Review” due to investment staff departures.

The report highlights that both the domestic and global REIT (hedged) sectors performed slightly below expectations, achieving 4.9% and 5.1% respectively for the 12 months to March. While this performance was materially down on the exceptionally strong prior year, it does support the thesis that REITs have returned to more traditional and conservative business models.

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Greater demand for private medical for health facilities will drive up property values.

Putting aside the fight brewing between the states and the Commonwealth over public healthcare spending, there could be a silver lining for investors, says Chris Smith, head of healthcare and retirement property funds at Australian Unity Investments.

“As it becomes more difficult, and more expensive, for governments to fund growing healthcare needs, an increasing number of Australians will turn to the private sector to meet their health and medical needs.

“As a result, there will be even greater demand for private medical centres, private hospitals and other allied health facilities, which will drive up their property value.

“Investors in healthcare property may reap the benefit of this in terms of both capital value and income yield,” Mr Smith said.

He pointed to three main areas that are driving demand for healthcare services –population growth; the increasing proportion of the population that will live beyond 65; and the dramatic rise in lifestyle diseases, which are typically the result of tobacco use, poor diet and lack of exercise.

“There will undoubtedly be ongoing and growing demand for healthcare and medical services that Federal and state governments will increasingly face difficulties in funding.

“According to the 2014-15 Budget papers, 16.1 percent of Federal government spending is provided for health. With this forecast to increase considerably over the forward estimates, it is increasingly likely that governments will move to limit services and expenses provided from the public purse.

“The outcome is that we expect the usage of private hospitals and private medical facilities will continue to rise, and the increased demand will ultimately require more space to expanding existing facilities and build new ones.

“At Australian Unity Real Estate Investment, we are continually seeing opportunities to further invest in developing our existing healthcare property assets. Both the pace and frequency of these developments have picked up substantially over the past few years, and we expect more expansions in the future will play an increasingly important role in the delivery of community healthcare services.”

Mr Smith said that for investors, the opportunities are significant.

“We continue to see a lot of interest in healthcare investments by both on and offshore REITs and institutional funds, which is a good indicator of the strong outlook for the sector.

“With retirees looking for strong and consistent income streams as higher term deposit rates roll off, healthcare property is increasingly worthy of consideration in a well-diversified investment portfolio,” Mr Smith said.

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Craig Mowll

Equity income strategies may have performed well in the last few years, but as quantitative easing is wound back and growth accelerates, can yield stocks really continue to deliver?

Absolutely, says Stephen Thornber, Fund Manager, Global Equity Income at Threadneedle Investments, who explained why investing for income can add performance over time, regardless of wider macroeconomic or stock market conditions.

“We believe there are fundamental reasons why high dividend companies outperform over the long term. Dividends demonstrate a commitment to creating shareholder value, promote long-term decision making, and reduce the risk that management makes poor investments.”

“Successful income investing is about identifying businesses that are paying high and growing dividends while sustaining a robust financial position. In a rising interest rate environment the importance of focusing on dynamic growing companies cannot be understated,” Mr Thornber explained.

“There is a misconception that performance of dividend stocks is closely linked to interest rates. In fact the majority of dividend stocks are priced by the market on a ‘total expected return’ basis against other stocks with similar prospects.”

“The exception to this is stocks we call ‘bond proxies’, typically companies that offer little or no growth, but a reliable income stream”. Regulated utilities or REIT’s would be good examples. These stocks are interest rate sensitive, and challenged by rising rates.”

Given the strong performance of the past few years, there is concern that equities may now be overvalued, and that investors should exercise caution.

Mr Thornber said that in his view equities remain attractive given valuations are at or below long term averages, and earnings are set to accelerate as a global recovery takes hold.

“High-dividend paying companies are trading at a discount to the broader market in every major market” he explained. “We are taking particular care when selecting companies in the US, where valuations are higher, but having said that, we feel the strong prospects for the US economy support higher valuations,” he said.

Mr Thornber continued by saying that dividend investing remains a sound investment approach for a number of reasons.

“For a start, current dividend payout levels are set to rise because corporates are in good health. In stark contrast to governments, corporates have done a good job of repairing their balance sheets in recent years. Cash generation is good, and because there is still reluctance to commit to large-scale capital expenditure, companies are using their cash in shareholder-friendly ways, such as dividend increases, special dividends and share buybacks,” he said.

In conclusion, Mr Thornber said that a global approach to equity income investing provided investors with a wider opportunity set.

“By adopting a global approach, investors gain access to economies which may be growing more quickly than their domestic economy.

“When managing portfolios, we aim to tilt the portfolio towards the fastest-growing industries and economies, spreading risk and increase total returns for our investors,” he said.

Threadneedle’s partner in Australia, Certitude Global Investments, reaffirmed that an equity income strategy is a particularly apt solution for local investors looking for international diversification.

CEO of Certitude, Craig Mowll said: “Australia represents only a small fraction of all investment opportunities, and local investors have recognised the need to diversify offshore. However, volatility in global markets is a concern for many Australian investors who want to preserve capital ahead of their retirement years. An equity income solution is therefore well-suited for investors who are looking to capture growth opportunities beyond our shores but still benefit from income that these dividend paying stocks provide.”

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US Fed tapering will benefit most asset classes: Principal Global Investors.

The delay in the US Fed tapering will likely benefit most asset classes, according to the latest Inside Real Estate report from Principal Global Investors.

The extension of the accommodative monetary policy has assisted the US REITs sector with recovering their losses, driven by Japan and the UK, despite investors shying away from the sector and increasing their exposure to cyclical stocks.

The report provides an analysis of the four quadrants from the US perspective, highlighting that even though capital market tailwinds have been given an extension in shelf life, the long term trend in Treasury rates is still upwards as monetary policy gradually returns to neutral.

Indraneel Karlekar, Head of Global Research at Principal Global Investors, is available to comment on the impacts that the US monetary policy will have on global real estate.

To read the entire report, please click here.

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Impact of Fed tapering to be felt in real estate market.

While there will be a ‘great rotation’ of capital out of bonds into other asset classes, it is likely that this will be unevenly spread across real estate quadrants, according to the Principal Global Investors US  real estate market report for Q2 2013.

The report highlights the upcoming prospect of Fed tapering of quantitative easing and the desynchronization of global economic growth as two dominant themes in the current market. These are positioning the US to assume a leadership role in economic growth and as its economy begins to gain momentum, investors will need to carefully monitor the interplay between shifting capital and space market dynamics as the monetary policy begins to make its presence felt.

Although those real estate quadrants whose trajectory of earnings growth is limited or fixed will be susceptible to downward variances in total return performance, the publicly traded REIT quadrant has the potential to provide leading indicator signals on the evolving interplay of capital and space market forces.

Included in the report is an economic outlook and extensive analyses of the four quadrants of the real estate capital markets.

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• Shadow Banking in China
• US crude oil has recached production levels not seen in 17 years, which has positive implications for chemical companies, energy generation and cheaper transportation.
• Australian REITs look promising on an income perspective.

http://www.youtube.com/watch?v=wkhMA1bAJ9s

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A-REITs outperform global counterparts

Principal Global Investors today released its quarterly update on Global Real Estate Securities revealing that Australian listed property stocks (A-REITs) outperformed their global counterparts in a quarter where overall returns were weak.

A-REITs have continued to produce attractive dividend yields, with top performers including those offering growth through acquisition and development. Other strong performers had exposure to offshore earnings which benefitted from the depreciating Australian dollar.

The report includes performance graphs and in-depth analyses of REITs in Australia, North America, Japan, Hong Kong, Europe, Singapore, the United Kingdom and in emerging markets.

To read the entire report, click here.

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There is always the danger that commenting on the economic and market impacts of an event such as the Sendai earthquake and the subsequent tsunami can be seen as trivialising the event; somehow downplaying the enormous human suffering. Nevertheless, there are consequences for the economy and for markets that require a considered response, without diminishing our horror and deep sorrow at the human cost of the catastrophe.

As this piece is being written, the official death toll in Japan stands at 3,373, and is expected to climb well above that figure. A series of explosions at the Fukushima Nuclear Power Plant has raised grave fears of a nuclear disaster. In the financial markets, share prices in Tokyo have now fallen by nearly 20% since the close of trade prior to the earthquake. Share prices across the region are also sharply lower today – particularly as  developments at the nuclear plant have worsened. The yen has strengthened against the US Dollar, perhaps reflecting speculation about, rather than actual, repatriation of Japan’s offshore assets.

It is too early for anything more than educated guesses to be made about the short-term negative impact on Japan’s economic performance, not least because the extent of the radioactive leakage from the Fukushima plant is highly uncertain. According to estimates from Barclays Capital, the affected area accounts for over 6% of Japan’s GDP, 6.8% of the population, and 7.2% of Japan’s private sector capital stock. At this point, analyst estimates of the initial adverse impact on GDP are utterly unreliable, as are estimates of the likely boost to measured economic growth that will result from the repair and reconstruction work. That said, it is still worth noting that all such catastrophes produce both an initial adverse impact on recorded economic growth, and then add to measured growth as the recovery work gets underway.The timing and the magnitudes involved are of course uncertain and highly variable.

What follows is our assessment of what the catastrophe might mean for the Japanese, world and Australian economies, and how MLC portfolios have been affected.

For Japan, the broad impact of the disaster on growth is likely to follow the pattern outlined above, however, there are broader issues at work also. Japan’s fiscal position is already dire, and the Government’s share of the reconstruction and recovery effort is likely to put enormous pressure on the nation’s finances. It is highly likely that taxes will need to increase, at least temporarily, to fund at least part of the cost and that is likely to have an adverse impact on private demand, which has been anaemic to begin with.

While Japan is the world’s third largest economy, the global recovery has not depended on Japan for its momentum – the contrary is true. Japan’s recovery has been highly export dependant. As Capital Economics puts it, Japan has been a passenger in the global recovery and not the main driver. The world is still a highly uncertain place, and there were ample issues to worry about prior to the quake and tsunami (peripheral Europe, the Middle East etc.). In saying this, the world economy is perhaps better able to withstand the kind of shocks currently being experienced than it was two years ago.

For Australia, Japan is still a major trading partner – the Australian Bureau of Statistics merchandise trade data show that in 2010 Japan took 19% of Australia’s goods exports by value, with resources accounting for the lion’s share. The short-term disruption to Japan’s industrial activity is likely to curb demand for Australia’s exports in the short term, however, the recovery effort is likely to be resource intensive, and provide something of a boost to our exports to Japan over time. At this point, we see no reason to change any medium-term view about the likely performance of the Australian economy or financial markets.

At MLC, our portfolios are extremely well-diversified across asset classes, investment managers, countries, industries, and individual securities. In the event of a catastrophe such as this, diversification is perhaps the only protection available to investors, but nevertheless, portfolios have been adversely affected, although some exposures within portfolios will actually have fared quite well.

In global equities, Japan accounted for 8.6% of the MSCI All-Country World Index at the end of February 2011. All except one of MLC’s global managers have Japanese exposure (Sands Capital being the exception). The overall portfolio, however, is underweight in Japan.

Moreover, MLC’s Japanese equity holdings have fared substantially better than the overall Japanese market, reflecting the high quality, and somewhat defensive nature of our holdings. While many of the Japanese companies we invest in will experience disruption to their businesses, it is also important to recognise that many Japanese companies are highly globalised, with production facilities and operations across many countries. The major car companies are an obvious example.

Our global listed real estate portfolios also have Japanese exposure, and some of the Australian REITs we invest in also have assets in Japan. Reports so far suggest that our exposure to the main affected areas is minor.

Australian shares have also fallen in value in recent days, and individual stocks we hold in MLC’s Australian shares strategy will have been affected – both adversely and positively – by the events in Japan. Among the insurance stocks we hold, QBE has already announced its exposure to Japan and its share price has suffered somewhat. However, its exposure is modest when viewed in the context of its overall reserves; the impact on MLC’s portfolio has been minor. On the other hand, other holdings in the portfolio, such as Bluescope steel has seen its share prices fare relatively well in the aftermath of the quake. In addition, MLC’s portfolio is significantly underweight resources stocks that have fallen further than the overall market in recent days, and has little or no exposure to the smaller uranium stocks, where prices have plummeted.

Within MLC’s debt portfolios, our exposure to Japanese debt securities has been minimal, reflecting the very low yields on offer in the Japanese Government Bond (JGB) market. Our exposure to Japanese corporate securities is virtually non-existent as spreads over JGBs have been way too tight to attract the interest of our managers.

Prior to this disaster a number of investment managers – both those we currently engage and those we do not – have expressed a view that Japanese equities were attractively valued, and even some traditionally cautious, value-oriented managers have noted that they were seeing opportunities in the Japanese market for the first time in many years. The market contains many quality companies with truly global franchises that will survive this disaster, and eventually continue to prosper. Moreover, there is a chance that this crisis will bring about the kind of decisive policy action that could help end Japan’s twenty-year long economic malaise. Please forgive the harsh end to this briefing note, but the role of our active managers, is to look through the human tragedy and seek out opportunities that inevitably arise in the wake of disasters, and that is just what they will be doing.

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According to the report, total returns from REITs are expected to be in the 8-12% range this year, as dividends grow and continue to be an important component of total return. The primary driver of real estate company returns will be growth in cash flow per share.

Rising interest rates need not be feared, as listed real estate often delivers positive returns in periods of economic improvement, even if interest rates rise, according to the report. The year will also see large scale IPOs emerging out of the US.

Region by region, in Asia Pacific, Hong Kong property companies are expected to outperform over the next 12 months, growing earnings by 15-20% and producing dividend yields of 2-3%. Japan should deliver a total return of 5-10% and Singapore 10-15%.

In Europe, Western and Northern Europe are believed to represent more attractive investment opportunities compared to Southern and Eastern Europe, with a 5-10% total return expectation across Continental Europe over the next 12 months and a 5-6% dividend yield. The UK is expected to deliver a total return l of 8-12% over the next year.

North America should see total returns of 8-12% in the US and Canada. In the US, property investment is predicted to be helped by economic recovery as a result of fiscal and monetary stimulus, although the continued depressed housing market and high unemployment remain as obstacles.

While property markets are at different stages in the real estate cycle, the earnings growth trend remains positive according to the report.

Click here to download the full report (pdf)

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Three new funds were added to Lonsec’s universe in 2010 – the Zurich Investments Global Property Securities Fund (Recommended), BT Global Property Securities Fund (Investment Grade) and the Resolution Capital Global Property Securities Fund (Investment Grade).

Key themes from the 2010 review

Performance dispersion

Global real estate securities rallied over the year, driven by an increase in market confidence and renewed appetite for risk. Thembi Matabiswana, the Lonsec analyst who spearheaded the review, commented, “We found that those fund managers holding high levels of cash were more likely to outperform the benchmark over the longer period.”

“Cash levels were generally in the upper ranges of permissible and historical levels which support this view.”

Lonsec accepts that higher than normal cash levels are to be expected given the possibility of increased redemption requests and the more defensive portfolio positioning of many managers. However, advisers should take care when reviewing fund performance so as not to confuse strong fund performance due to high cash levels with strong fund performance due to stock picking skill.

While absolute returns have been positive in the 12 months to 30 November 2010 (average 20.9%), over a three year time horizon performance has been poor. When comparing managers across the sector, the dispersion between performances over the longer term continues to be high.

“Over the three years to 30 November 2010, ING was the top performer. This outperformance was largely driven by the manager‟s emphasis on top-down macroeconomic variables and effective re-positioning of its portfolio to accommodate changing market cycles,” said Matabiswana.

Access to equity and debt markets

REITs continued to tap both equity and debt markets throughout 2010, representing a material increase in activity from 2009. European real-estate securities in particular experienced a significant turnaround during the third quarter, driven by improving economic data and broad anticipation of additional quantitative easing programs.

“A report prepared by Jones Lang LaSalle stated that Europe dominated cross-border investment activity over the first half of 2010,” said Matabiswana.

“The report specifies that global real-estate investment totalled US$132 billion, almost double for the same period in 2009, with more than 50% of this occurring cross-border in Europe.”

As it stands, REITs continue to enjoy far superior access to capital compared to their unlisted real-estate counterparts and are therefore well positioned both offensively and defensively as economic recovery continues to strengthen or worsen.

Currency headwinds

The Australian dollar has experienced a significant amount of volatility over the last two years. The largest fall was seen over the three months to October 2008, where the Australian dollar dropped from a high of 91 cents in July to as low as 60c. With all the funds in the review offering fully hedged products, most of them have been unable to pay distributions as a result.

This is because July 2008 saw tax law changes that required all classes of income to be included in the calculation of taxable income. This included realised currency hedge gains/losses. Realised currency losses, in some instances, reduce the level of distributions that a fund can pay, if significant enough to cause a net loss on its taxable income. Importantly, currency losses continue to be carried forward until they are completely offset by future income.

“Therefore, for most of the hedged funds, such currency losses will continue to be carried forward until they are completely offset by future income. It is therefore possible that some funds‟ future distributions may continue to be affected by previous currency losses,” said Matabiswana.

“AMP and RREEF were the exceptions as these managers have continued to pay distributions; they have done this by funding the hedging losses through the sale of stock in the portfolio.”

In fact, both approaches should result in a similar outcome and not have a material effect on total returns. Those funds that will reduce or not pay distributions will benefit by a commensurate increase in their Net Asset Value (NAV) per unit. Those funds that do pay distributions will fund this by selling down a portion of their portfolio. This will act to reduce their NAV equal to this distribution amount.
Greater conviction at the regional level, for a more active global portfolio

In the past Lonsec has criticised managers for not being active enough at a global portfolio level. Managers’ active positions relative to their benchmarks were considered too small when compared to other sectors. This continues to be the case with high fees for mid conviction “active management”.

This is particularly disappointing given the extensive investment teams and resources afforded to most “active” global property securities fund managers.

“Some managers, such as RREEF and Principal, have acknowledged this. These managers have undertaken further research at a portfolio construction level and found that in order for an active position to be significant at a global level, there would have to be sufficient flexibility to take even larger regional bets,” said Matabiswana.

“These managers have adjusted their risk management systems accordingly, as well as encouraging regional teams to take larger active positions. Lonsec continues to encourage this evolution in portfolio construction, as long as it is supported by adequate resourcing and the appropriate tools and systems.”

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