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Property principles
Alan Borrows Multi-manager View
Of all the questions facing multi-manager/multi-asset fund managers running income funds, the issue of where to generate income is among the most important.
The rallies over recent months in the equity market and the investment-grade corporate bond market have been substantial. Between February and October, Bloomberg’s estimate of the forward yield on the UK equity market has fallen from 5.9 per cent to 3.6 per cent while the Itraxx main index showing the risk premium on European investment-grade bonds has more than halved. We still believe the outlook for these asset classes remains positive but the scope for capital growth from here is more limited than was the case earlier in the year and the level of inc-ome yield is obviously lower. Similarly, the yield on gilts and cash is extremely low.
As an alternative source of income, we have begun to look more kindly on the UK property market. I would always want to include an element of property in a balanced, multi-asset fund, both as a diversifier and for the opportunities it brings in its own right. This said, we sold out of UK property in 2007, believing the market had peaked, and bought a number of overseas property investments focused on the Far East and parts of Europe.
There are now signs that valuations in the UK commercial property market have achieved some stability while income yields are looking relatively attractive compared with other asset classes. There are signs of very modest increases in capital values in the prime area of the market and the initial yield on the IPD index stood at 7.7 per cent at the end of August.
In selecting investments in this area, we have three principal criteria. First, did the managers, on balance, make good calls over the financial crisis and bear market by increasing their levels of liquidity before the storm? Second, did the managers keep their doors open throughout the downturn, enabling investors to invest and redeem monies with reasonable liquidity? Third, is the mix of the portfolio sufficiently focused on the prime market and well enough tenanted, in terms of occupancy, quality and spread, to withstand the impact of continued economic weakness? Against these criteria, a number of investments in this area are now looking attractive.
The Ignis UK property fund is one. This is a significant fund of in excess of £400m with a well diversified base of properties and tenants across a broad range of assets by geography and sector supported by a low vacancy rate. It offers a current income yield of 5.5 per cent. The Swip property trust is again a well diversified fund with a broad spread of rental income and an attractive yield. As the funds invest further cash, these yields should rise.
Investors with a more positive outlook can also expect some longer-term capital appreciation, although this may be some way off. If the economy returns to a growth path, albeit muted, property, as a real asset, has the capacity to pull itself up by its bootstraps, which is more than can be said for some of the more traditional sources of income, especially if inflation begins to creep up.
Alan Borrows is lead manager of CF Midas balanced income fund
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