Pros and Cons for Listed Property Equities
There are many benefits to seeking property exposure indirectly through listed property equities. Potentially the most important is the liquidity factor: being able to gain exposure to underlying property assets which can be traded daily through the global stock markets. There is also the added incentive of transparency from stock market regulation and another interesting point is the ability to gain exposure to high quality management teams who are incentivised to provide strong long-term returns. In addition, accessing a variety of regions and shifting between regions in a timely manner is possible in global property securities, allowing fund managers to switch between regions/countries which are experiencing stronger economic phases.
On the downside, in the short-term these securities tend to act more like equities, resulting in higher volatility than investing in property directly. Development risk and leverage are also issues that investors should be mindful of. High levels of leverage became evident to investors during the credit crunch with the collapse of several high profile listed property companies.
The Growth of REITs
Over the last decade the listed global property market has developed significantly, with the introduction or modification of legislation across the globe to allow real estate investment trusts (REITs) to exist in many regions rather than a mere handful, such as the US and Australia where they were originally borne out of. The UK’s first REITs were converted in early 2007.
In order to achieve REIT status, property companies typically have to commit to paying out a minimum portion of their earnings (rental income) as dividends, and in return they receive tax or operational concessions from the government. It is this tax shelter that has increased the benefit of investing in REITs dramatically and has created further demand for this income-oriented asset class.
Bouncing Back from the Credit Crunch
The sector was also one of the worst affected from the onset of the credit crunch, unsurprisingly given its origins being the US sub-prime market. However, since then the companies have typically recapitalised and are now better positioned with stronger balance sheets. In fact it is surprising how resilient the sector has been so far in 2012, even with no credible long-term resolution to the European sovereign debt crisis in sight.
With stronger balance sheets and compelling valuation levels, property companies have managed to make good headway this year and are among the top performing sectors. This only further highlights the point that investors are subjected to high levels of volatility here; the sector experienced inflated valuations prior to the financial crisis, which was the result of massive inflows into the sector, then the sector collapsed as its heavy reliance on financing proved incredibly detrimental. Now we have arrived at a point where it would seem the sector was dramatically oversold going into 2012.
Beating the Benchmark: Too Much to Ask?
The European-based Morningstar Indirect Global Property category for funds has grown by around 20% (in number of fund terms) since the beginning of 2010, which highlights the popularity of the sector, even though the majority of funds have struggled to beat the index, as measured by five year annualised returns against the FTSE EPRA/NAREIT Developed benchmark. Indeed, the proportion of funds that have outperformed the index over the five years is at a similar level to that of the North American sector, which is commonly referred to as a tough region for finding consistently outperforming funds.
We regularly question whether fund managers in this category are willing to take enough risk in order to generate a sufficient return for investors after fees. Interestingly, the passive fund, 
ishares FTSE EPRA/NAREIT Developed Property Yield ETF (IWDP) is one of the largest in this investment category and is also one of the best performers over the last three years! Of course the sector does have its limitations, and it is worth noting that the FTSE EPRA/NAREIT Developed index consists of only around 250 individual holdings and the North America region also accounts for a large exposure, at around 50%. Our observation leads us to believe that the FTSE EPRA/NAREIT developed index is one of the more popular indices that funds are benchmarked against. Others include the UBS Global Real Estate index and the S&P Developed Property index. The US weighting is the most notable difference between the FTSE EPRA/NAREIT Developed index and the UBS Global Real Estate index, as the latter benchmark has around an additional 10% exposure to the region.
In part as a reflection of the difficulties that many funds encounter in outperforming the index, Morningstar OBSR have never awarded a rating higher than a Bronze level to funds in this category. However we do rate a small number of propositions where we believe the combination of depth of resource and quality of fund management does give the potential for long-term outperformance.
Property Investment: The Largest Funds
The largest funds in this property sector account for a large proportion of the assets managed over the entire sector. The resource required to cover the sector thoroughly is large and generally creates a barrier to entry for fund launches; on the ground presence in the key property hubs around the globe is generally a pre-requisite in understanding local property fundamentals.
The Schroder ISF Global Property Securities fund (Research Report) is rated Bronze by Morningstar OBSR. Schroders has outsourced management to European Investors Inc (EII) and fund managers Jim Rehlaender and Al Otero are both incredibly well experienced in the property industry. The managers are supported by a team of regional portfolio managers and analysts. The investment approach combines top-down and bottom-up analysis incorporating both qualitative and quantitative factors. The team at EII looks for companies that trade at a discount to the underlying real estate value, but also emphasise the quality and execution of management as a key consideration before investing.
The Henderson Horizon Global Property fund is rated Bronze by Morningstar OBSR and is managed by Patrick Sumner, who heads up the wider Henderson’s global property securities team. They have teams based in both London and Singapore and rely on an external company, Harrison Street Securities, for the management of the US portion of the portfolio. Asset allocation is determined by the portfolio manager in conjunction with the regional heads. The approach within each region is tailored to suit local conditions, based on the belief that market characteristics can vary widely around the world. While macroeconomic and top-down research is an important input, they expect to generate most of their alpha from stock selection by identifying undervalued securities.
The Fidelity Funds Global Property fund is managed by Steve Buller who leverages off the extensive network of Fidelity’s global property research team which are located across the globe. The investment process is strongly bottom-up focused and is based upon rigorous analysis of company assets, the quality of their property tenants and the track record of the management team. The company-specific research focuses upon the strength of management, quality of the balance sheet, its market positioning and earnings growth. The fund features between 50– 80 stocks, with the top 10 typically accounting for around 35% of the portfolio.
Property Investment: Best Performance Over Three Years
The Robeco Property Equities fund (Research Report) has been managed by Folmer Pietersma since October 2007 and the fund is benchmarked against the S&P Developed Property index. From the top-down, the team aims to identify long term growth themes and trends in the property sector. The team then apply fundamental research in order to select the most attractive equities that fit these themes. The portfolio typically comprises 50 - 75 stocks and aims to be fully invested with a beta close to 1.
The Aviva Investors Global REIT has been managed by Paul Van De Vaart since January 2007. The manager seeks to provide investors with broad exposure to the global listed property market through diversifying by both country and sector. The process incorporates a combination of top-down regional allocation and bottom-up stock selection. The qualitative analysis element involves detailed company meetings and site visits, while quantitative analysis involves detailed financial analysis, return projections and risk assessment. Aviva Investors have a strong market position within the property asset class and are based in many key property locations, which is an additional benefit.
Property Investment: The Newcomers
A high proportion of the newcomers listed here comprise of passive investment offerings. This is unsurprising since actively managed property equities funds have, on average, failed to beat their relevant benchmarks over various time periods. Newcomers include the HSBC FTSE EPRA/NAREIT Developed ETF (HPRD) and the db x-trackers FTSE EPRA/NAREIT Global Real Estate ETF (XGLR).
The HSBC FTSE EPRA/NAREIT Developed ETF provides a more cost efficient way for investors to gain access to the listed global property market. This ETF has a total expense ratio of 0.40% and uses physical replication to track the index. The fund aims to invest assets proportionately in the stocks underlying the FTSE EPRA/NAREIT Developed index; however, it may use financial derivative instruments to replicate the performance of selected securities.
The original version of this article appeared in International Adviser.
