This article is part of Morningstar’s Guide to Investment Trusts, highlighting the benefits of these unique investment vehicles – busting the investment trust jargon, revealing potential pitfalls and celebrating those experienced managers who have earned the top ranking from Morningstar fund analysts.
Emma Wall: Hello, and welcome to the Morningstar series Ask the Expert. I'm Emma Wall, and here with me today is Portfolio Manager for Morningstar, Cyrique Bourbon.
Hello, Cyrique.
Cyrique Bourbon: Good morning, Emma.
Wall: So we're here today to talk about property investment trusts. You hold some of these in your portfolio. Why are closed-end funds more suitable to hold illiquid assets such as property?
Bourbon: So the main difference between closed-end vehicles and open-end vehicle is, obviously, what happens in terms of cash flows, and closed-end vehicle effectively being a company, has a capital structure which is much more steady and much more stable.
Open-end mutual funds obviously suffer from in and outflows from investors, and obviously, this affects the underlying investments directly.
Wall: Open-ended funds came into trouble, property funds in 2008, everybody wanted to take their money out and of course, you can't liquidate a house like that. Anyone who is trying to sell a house in the U.K. or anywhere knows that; but the closed-end fund, you have to have a buyer and a seller and it stops those, as you say, mass outflows at times when perhaps people want to take their money?
Bourbon: That is correct. Obviously, the big thing to remember is that you can still get hit in the closed-end vehicle when you are trying to sell some shares at a time where the asset class is out of favour, because their might not be buyers at the price willing to sell those shares effectively; meaning that you get the price of the trust moving from potentially a premium to net asset value to a significant discount to net asset value.
So in times like 2008, yes, you can definitely sell your shares, but you can potentially sell them at 20% or 30% cheaper than the underlying value of the property book.
Wall: What property investment trusts have you got in your portfolio at the moment?
Bourbon: So we currently hold the F&C Commercial Property Trust (FCPT), which is one of the biggest trusts in the sector. We have got two smaller positions in smaller vehicles, the Schroder Real Estate Investment Trust (SREI) and F&C U.K. Real Estate Investment Trust (FCRE), which are more invested in smaller properties and slightly higher yielding properties; some of them more exposed to non-prime areas of the property market.
Wall: 2014 was a really good year for commercial property and a lot of funds, both open and closed-ended saw great increases in their value. Looking at 2015, we can't really expect the same again, can we?
Bourbon: No, we can't and roughly 20% returns from U.K. commercial property that we saw last year definitely seem unrealistic to expect this year. However, we're thinking that given the current yield levels, it's still relatively easy environment, not boring and also the potential for rental growth with yield at about 5.5% currently you can expect roughly about half of the total returns for 2015 to come from income and half from capital growth. So, potentially about high-single-digit, low-double-digit returns for the asset class.
The one thing to remember going back to investment trusts is those vehicles typically price in ahead of the moves those potential significant returns. So, a lot of the property investment trusts do trade at a substantial premium to net asset value. So, for instance, the F&C Commercial Property Trust trades currently at about 17%, 18% premium to the latest net asset value which is the end of December 1.
So, there's definitely a lot of expectations built in there already. So, we are quite cautious over in terms of using investment trusts and in general, the liquidity that has gone into both at closed-end vehicles and open-end vehicles means that there's potential for liquidity issues to come back into the asset class. So, we'll be slowly taking profits from those positions in the coming weeks and months.
Wall: So, income assets are expensive, no shock there?
Bourbon: There is a lot of demand for income and that's valid for bonds, for equities and obviously for property which has been a key theme and very popular asset class in the last couple of years.
Wall: Cyrique, thank you very much.
Bourbon: Thanks for having me.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
