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Asset allocation: Equilibrium proves smaller is better for property

Liquidity is never far from the mind of anyone investing in bricks and mortar but Equilibrium Asset Management partner and investment manager Mike Deverell says the scale of a wealth management firm and its ability to monitor trends in the sector can help to tackle the liquidity issue.

Equilibrium runs a total of four model portfolios, with its Balanced portfolio currently home to five property funds, all investing in direct property only.

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Signs of recovery in the UK economy encouraged the firm to invest in property and it is a trend Deverell (pictured) believes has further to go against the backdrop of strengthening economic growth.

He says: “We have done a fair bit of research comparing the Investment Property Databank index with economic growth and we know property is highly correlated to the economy.

“With the economy doing better over the last 18 months it made sense that property was a good place to put money. Property as an asset class has done fantastically well in the last 12 months and you still get a much better return on a rental yield from a property than from cash, a bond or anything else, by a long way.”

Rental income growth has still to come through in property while the number of vacant properties still remains high, according to Deverell, but the eventual improvement in these two areas of the sector should only act as another boost for the asset class.

He adds: “You would normally see rental growth roughly in line with inflation over the long term and we have not been seeing that, but if we can get back to these kind of levels then this is another attractive feature of property.”

Although positive on the outlook for the property sector, Deverell predictably has one eye on liquidity. However, he argues the scale of Equilibrium’s operations mean  liquidity is not such an issue as it would be for other, bigger, wealth management firms.

Property exposure 

Equilibrium currently has just under £400m under management within its model portfolios, with £16m invested in each of the five property funds held in its Balanced portfolio.

“We are already at a point where we couldn’t sell this overnight anyway but if you are one of the big wealth firms you would probably have to have around £100m in each property fund and then you have got even more of an issue,” he adds.

“That is where you’ll find the big discretionary managers will have much lower property exposure than we are able to have.”

Trends in property are also “easier to spot” than in other assets such as equities, which can move up or down on a daily basis, says Deverell. The team at Equilibrium keeps a particular eye on possible slowing cashflows into property funds as an indication of when it may be time to move out of the sector.

The Balanced portfolio is planning to increase its exposure to property  and may look to boost liquidity and diversification through the addition of a property derivatives fund, North Row Liquid Property, which is co-owned by Brooks Macdonald.

Backing small caps 

Conviction in the UK’s economic recovery also sees Equilibrium favour smaller companies within its exposure to UK equities as part of the Balanced portfolio, which currently has a slight underweight to equities relative to its benchmark. However, Deverell says smaller companies represent better value compared with other areas of the UK market, thanks to earnings growth at the lower end of the market cap scale.

He says: “Smaller companies are more economically sensitive, so we  prefer this area of the market at this stage in economic recovery.

“The UK market as a whole is also looking fair value at best, plus the earnings just haven’t been growing well, particularly in the larger end of the market. Whereas if you look down the small-cap tier there has been some fairly reasonable earnings growth for a while now.”

Deverell favours what he describes as “specialist, long-term and experienced” fund managers such as Gervais Williams and Giles Hargreaves when it comes to investing in the UK smaller companies space.

Similar concerns over valuations and earnings have prompted Deverell to underweight European equities in favour of Japan, where the market is not only undervalued. Corporates are also showing signs of earnings growth.

“Europe was already overvalued relative to its long-term average and earnings have been falling, with these falls getting worse not better. The European economy has got its
issues too, with parts doing okay and then other areas such as France that are getting worse,” says Deverell.

Japanese earnings growth

“When we look at Japan, by contrast, it is undervalued, earnings are growing and the central bank is doing a huge amount of quantitative easing. Some recent economic data has
been a bit bumpy but you don’t just focus on the Japanese economy because these are global companies. So when the global economy and US economy are doing better this helps Japan.”

Equilibrium currently has exposure to Japan through the £1.4bn Schroder Tokyo fund, which has been a feature of the Equilibrium portfolio since inception. More recently, the firm added the £574.2m Baillie Gifford Japanese fund as a way of diversifying into Japanese smaller companies.

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