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Property principles

Property is one of the mainstays of diversified portfolios but despite the brief period of popularity it had in early 2010, it remains riddled with problems and negative sentiment. The latter is not necessarily from a fund manager’s point of view but from advisers, as evidenced by the significant drop-offs in sales. But has the hype of negativity over property gone to far? Yes and no.

Performance-wise, property funds have had a bit of a rocky period but not as bad as the press they get would imply. Over the year to end of 2010, on a bid-to-bid basis, every fund bar two in the IMA’s property sector has achieved positive total returns, Financial Express data shows. The worst performance came from Swip’s UK real estate fund and a European residential property portfolio from Tri, which fell by 1.62 and 23.30 per cent respectively.

The rest of the 44 constituents in the sector posted mostly double-digit gains, putting the average return in the sector at 13.41 per cent. That is far better than the average gains over the past year from any of the IMA’s bond sectors and while equities may have done better in 2010, UK equity funds did not surpass property by much. The average UK all companies gain over the year, on a bid-to-bid basis, was 17.53 per cent while equity income portfolios had a mean return of 14.58 per cent.

In keeping with good equity returns, it is not too surprising that the top property performers over 2010 were mostly property securities funds. Bricks and mortar portfolios suffered from a cash drag on returns following a rapid and short period of solid inflows.

In December, L&G UK property trust manager Matt Jarvis said he was grateful that inflows had slowed somewhat as it was affecting performance. He said: “Over the year, we have incurred an awful lot of expense as the fund has grown significantly, more than doubling in size, and as such we have incurred some purchase costs. This has slowed since the very high levels of inflows we saw over the first half of 2010 and, in a way, I think that is a relief. The level of growth at the moment is about £4m-£5m net a month. That is sustainable.”

Certainly, sales figures imply this slowdown trend is sector-wide. In the fourth quarter, property accounted for 3.5 per cent of net sales on the Cofunds platform, down from 4.3 per cent in the previous quarter and significantly down from 9 per cent in the first three months of 2010. Yet that has not stopped some groups from issuing new property investments. Schroders is capitalising on its maximiser franchise to launch a global property fund later this month. The group is banking on the appeal of the capital returns offered by property securities and the income of the asset class itself, targeting a 7 per cent yield. Like its other maximiser products, it will use a call option strategy to help with the yield requirements.

It is not the only property fund using derivatives to an advantage. Jarvis says his fund has around 7 per cent, as of last month, in derivatives and this has been a solidly performing part of his portfolio. He says: “All our derivative trades to date have returned a profit and those we have open at present are also in a profit position.”

Lukewarm expectations for property for this year mean it is likely that other portfolios will also adopt similar strategies, if they are not doing so already. Whether they are is difficult to tell – it is not exactly featured predominantly in many fund fact-sheets. But then, neither are cash weightings – a key piece of information for a bricks and mortar fund – so whe-ther or not these remain high and a drag on performance is tough to tell.

In looking at the factsheets of many of the leading property funds, only a few make their cash position relatively clear. For instance, Aviva property trust currently has around 18 per cent in cash instruments. Aviva was one of those experiencing good inflows last year. It, along with M&G property portfolio, L&G UK property, Threadneedle property trust and Swip property were the fifth-biggest net sellers in that sector on Cofunds in 2010.

The outlook for property for the year ahead is somewhat subdued but many managers are not bleak about the sector’s opportunities. Threadneedle UK property trust’s Don Jordison says the pace of decline in rental values has eased and he is noticing signs of rental growth in areas such as central London offices.

Swip director of real estate Malcolm Naish says there may be a risk that investment demand for property will deteriorate, causing values to fall, but he too remains convinced it is not all bad news for the sector. He says: “Although capital growth may be more subdued, total returns are expected to average just over 6 per cent per annum in the three years from the end of 2010. With prices still well below their peak in mid-2007, good oppor-tunities in select locations are out there for the long-term investor.”

With managers’ wary but relatively upbeat, cashflows at more manageable levels and with the ability to use instruments such as derivatives to aid returns, advisers should have some confidence in this sector. However, this fund sector needs to do more in terms of communicating what it is doing and how before greater clarity, and consequently greater confidence, is had by anyone. Cash weightings and derivative use could be better highlighted but there are other ways as well.

As the IMA pointed out recently, about £1.6m a year is paid to the tax authorities from property funds within Isas instead of to the end investor. Groups could offer tax-efficient funds known as property authorised investment funds, which do not indirectly suffer corporation tax.

The rules allowing these vehicles have been around for some time and yet to date they have not been widely adopted by the industry. Some say this is because platforms are illequipped to handle them. Of course, there is also the old adage that “if you build it, they will come”, so it is not fair to place all the blame with platforms.

Property is a key asset class for investors, so it is a shame that there remain so many opaque practices and less efficient ways to access it. Perhaps if more were done in these areas, the inflow fluctuations seen by the property sector in recent years would not be quite so sharp.


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