01 May 2019 Building blocks for gatekeepers
After a year like 2018, it’s no surprise if some advisers’ minds turned to so-called safe havens. One asset class that used to fall into that classification was Property.
Historically, Property funds were plain vanilla, containing UK-based offices, supermarkets and warehouses with a wodge of cash – often up to 25% – to provide liquidity for exiting investors, given the lengthy process of selling properties. Prices rose slowly but inexorably, accounting for rental and occupancy, while agents constantly upvalued the bricks-and-mortar in the absence of a sale price.
Not just bricks and mortar
Today, Property funds fall into a number of categories. UK Direct Property funds hold bricks-and-mortar and have no liquidity limits other than FCA TCF guidance. When outflows exceed inflows, at the extreme funds are gated, ie limiting redemptions until cash is realised from property sales.
Other funds consist entirely of Real Estate Investment Trusts (REITs) and equity in Property companies. This provides liquidity, but at the cost of higher daily volatility. Yet more funds are focused on ground rents, others on residential property, student accommodation and social housing and so on. Geographically there is no limit to the opportunity, with seemingly no jurisdiction being off-limits.
The diversity of Property sectors certainly provides choice, but a dilemma too. Most asset allocation models recognise and define the asset class in terms of directly invested commercial property. Having a ‘mongrel’ sector of 60-odd diverse funds ostensibly investing in Property would have caused some confusion for fund selectors.
In September 2018 the Investment Association split the sector in two. Specifically, the UK Direct Property sector includes 17 funds investing at least 70% of their assets directly in UK commercial and residential property, along with student accommodation, leisure and healthcare assets. The other Property sector, ingeniously named ‘Property Other’ includes over 30 funds investing in everything else — property securities, direct funds with a specialist mandate, and hybrid funds
When alpha turns negative…
In 2018, the average Direct Property fund rose by just under 4% — the only non-cash sector to do so. Property Other meanwhile lost over 3%. Gatekeepers have clearly focused their attention on Direct Property. The leading fund by picks is Janus Henderson (24), but it produced an Alpha figure that is on the face of it shocking, ie -24 over a year. In fact, the fund price rose by 4.78% during 2018, beating the sector, so how is Alpha negative?
There is a problem with performance measurement where illiquid assets like Direct Property are concerned. Alpha is outperformance, but accounts for relative risk versus the benchmark — in this case, the sector average. The Henderson fund had a Beta of ~8 because it was over 10 times more volatile than the sector. That volatility was caused by repeated changes in pricing basis — nothing to do with the portfolio — but simply flows in and out of the fund. Investors need to be aware of these performance measurement anomalies before making decisions based on past performance.
Absolute performances were very narrowly distributed, with shifts in pricing basis having significant impact on price volatility and hence Alpha. Changes to fund structure and sector moves also had an impact, with new names coming to the fore. At first sight, the clear winners in that sector over 2018 were Time Investments, with three funds in the top 5 Alpha producers. However, their Social Infrastructure fund was only available to retail investors from October 2018, while their Freehold Income fund is monthly traded. The Commercial Freehold fund has recently been reconstituted as the Commercial Long Income fund. Gatekeepers may well be paying more attention to TIME Investments in future.
Among gatekeepers, The Property Other sector is dominated by the iShares Global Property Index fund, on 18 lists. Aberdeen Property has 14 selections, while BMO Property Growth and Income has 12. Being REITs funds for the most part, these funds suffered through 2018, positive Alpha numbers masking the fact that less than half of the funds produced a positive return. The leading fund was Janus Henderson’s Luxembourg SICAV Horizon Global Property Equities fund, which appears on one list. Most of the funds in this sector, by their nature, exhibit equity-like volatility, given their securitised holdings.
However, one notable exception is the £56m TM Home Investor fund, managed by Hearthstone Asset Management. The fund invests in a portfolio of over 200 residential properties which are then let under assured shorthold tenancy agreements (ASTs) and corporate lets.
The fund had a remarkably low volatility (due to investment in bricks and mortar) with a return of a little under 2.5% and a diversification benefit through a Beta of zero — the fund is effectively uncorrelated with others in its sector. This produces another Alpha anomaly, given the maths of the calculation, with an Alpha lower than their sector competitors that are showing negative returns and higher volatility!