Foreword
By Annabel Brodie-Smith
This year for Bonfire Night we went to the local village display at Dorchester on Thames. As well as the essential fireworks and bonfire with guy, there was a games tent with a coconut shy and hook the duck, a bar tent manned by friendly locals, homemade cakes and hot dogs. It was completely different from our usual evening with the tens of thousands at Battersea Park and all the better for it!
There have been plenty of fireworks in markets recently, with October being a tough month. Worries including the escalation of the trade war between China and the US, rising interest rates, FAANGs being overvalued, Italy’s budget deficit row with the EU and Brexit resulted in markets heading south. It’s therefore timely this month to look at the investment companies whose aim is to limit volatility and preserve investors’ capital. It’s fascinating that in 2008, the year of the financial crisis, Ruffer Investment Company and Capital Gearing were two of just six investment companies that had a positive return that year. Of course, no-one can second guess the markets’ next move but it’s worth hearing what the managers with an objective of protecting value and limiting market swings have to say.
We’re also taking a look at property investment companies this month. Investment companies give investors access to a wide variety of different property types, ranging from office buildings and shopping malls to social housing and ‘big box’ logistics warehouses. The closed-ended structure makes investment companies particularly well suited to investing in assets like property. This is also demonstrated by their substantial outperformance and higher yields when compared to open-ended property funds. We hear from a number of property fund managers to understand their views on the impact of Brexit, the changes on the high street and the outlook for property.
Our investment expert, Ian Cowie gets under the skin of property investment companies, highlighting the attractive yields, namely, 5.2% in the Property Direct – UK sector but also the opportunities and risks this sector offers. Ian explains the important structural benefit of investment companies when it comes to investing in property in comparison to open-ended funds and why these factors “explain why commercial property investment trusts tend to offer higher yields than their open-ended rivals and, with very few exceptions, have delivered higher total returns over the last year, five and 10-year periods.”
Finally, we have produced an educational animated video to help people new to investment. Perhaps you know someone who would like to watch this video, ‘Your investment journey’, which explains why you might want to invest, how to go about it, and where investment companies fit in.
We have also introduced a series of 10 short animated educational videos which explain key investment terminology such as dividend yield and share prices, and investment company features like gearing, discounts and premiums.
Have a good November.
Annabel Brodie-Smith
Communications Director, AIC
Preserving capital
We hear from investment companies who aim to preserve investors' capital and limit volatility
Investment companies have been adapting to meet investors’ needs for 150 years. As well as offering exposure to markets around the world and specialist asset classes like infrastructure and private equity, there are several companies in the Flexible Investment sector whose aim is to limit volatility and preserve investors’ capital.
With the return of market volatility, the Association of Investment Companies (AIC) has gathered comments on this approach and the outlook for markets from investment companies with multi-asset and capital preservation strategies.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies said: “Recently, it’s been a turbulent time for markets and it’s useful to know about the investment companies whose objective is to protect investors’ capital and limit volatility, come rain or shine. Of course, no-one can second guess the markets’ next move, and it’s important for investors to take a long-term view and have a balanced portfolio. But the potential to protect value and limit market swings could be a useful tool depending on an individual investor’s needs.”
“It is very possible that we are entering a more difficult period, and multi-asset funds, unlike single asset class funds, can help navigate these choppier waters.”
Peter Elston, chief investment officer of Seneca Global Income & Growth
Opportunity for investors
Hamish Baillie, investment director at Ruffer Investment Company said: “Our near obsessive principal objective is to protect our investors’ capital. Unusually, we measure this over the very short timescale of 12 months. The principal behind this is that we would like to be genuinely uncorrelated with equity markets; our investors typically hold shares in the company alongside an equity focussed portfolio and so we want to be there to be called upon when other assets have fallen in value. The nature of the power of compounding means that superior long-term returns will be achieved by preserving capital in the bad times.”
Peter Elston, chief investment officer of Seneca Global Income & Growth said: “The last 40 years have been very easy for financial markets and thus for investors, driven as they have been by falling inflation and interest rates. It is very possible that we are entering a more difficult period, and multi-asset funds, unlike single asset class funds, can help navigate these choppier waters.”
Alastair Laing, manager of Capital Gearing said: “Our approach could be described as extremely circumspect. Our portfolios combine a restrained exposure to equities and a majority exposure to short duration high quality bonds. The cost of timidity is forgone opportunity today. However, the cost of greater courage is all too often forgone opportunity at the time it really matters. The best returns across the cycle come from increasing equity exposure after a bear market. In order to exploit those golden opportunities you need to make sure you are not fully invested when you discover where the cliff edge is.”
Katy Thorneycroft, co-manager of JPMorgan Multi-Asset Trust plc said: “We aim to construct a portfolio which is designed to be flexible with respect to asset class, geography and sector of investments and will seek to achieve an appropriate spread of risk by investing in a diversified global portfolio of securities and other assets. This flexibility allows us to take advantage of the best opportunities to generate income and growth. We take a medium to long-term view of markets, acting on investment themes that we believe are appropriate for such periods.”
Outlook for markets
Hamish Baillie, investment director at Ruffer Investment Company said: “We are very worried about the outlook for equity markets. There are pockets of value, but many parts of the market are overvalued and the combination of structural fragilities in markets, lower levels of liquidity and the rise of unthinking passive strategies means that the next downturn is likely to be particularly vicious. Perhaps most worryingly, bonds may not provide the offset that they have done for the last 25 years and so a typical balanced portfolio will find that both sides of the fear/greed strategy fall in value.”
Peter Elston, chief investment officer of Seneca Global Income & Growth said: “Economies are in the late stage of their cycle, and low or falling unemployment is translating into rising wages. This means tighter monetary policy, which is putting pressure on financial asset prices. A global recession is not imminent, but one should be preparing for it. Brake ahead of the bend, not when you reach it.”
"There are pockets of value, but many parts of the market are overvalued and the combination of structural fragilities in markets, lower levels of liquidity and the rise of unthinking passive strategies means that the next downturn is likely to be particularly vicious"
Hamish Baillie, investment director at Ruffer Investment Company
Alastair Laing, manager of Capital Gearing said: “There is a growing consensus that the current macro-economic and financial environment is ‘late cycle’. Some indicators are relatively simple to observe, namely that the current US economic expansion and equity bull market are both the longest since the second world war. Other indicators are based on historic echoes such as the Federal Reserve embarking on a tightening cycle resulting in a flattening yield curve. These all point to a cliff edge out there, shrouded in the mist that is the future.”
Katy Thorneycroft, co-manager of JPMorgan Multi-Asset Trust plc said: “Global growth is set to remain above trend but changes to US trade policy and the impact of higher US rates have increased the risks to our outlook. We retain our pro-risk tilt, anticipating an economic and earnings environment consistent with equity outperformance, but moderate our conviction and will look to trim equity positioning a little.”
Asset allocation
Hamish Baillie, investment director at Ruffer Investment Company said: “Reflecting the above, we are running a relatively low equity weighting at 40% focussed on cyclical and value stocks and some special situation growth businesses. Japan has been a particularly productive hunting ground in this respect. We hold 33% in index-linked bonds in the UK and the US to benefit from an increase in inflation greater than any rise in interest rates. 7% is invested in gold and gold mining shares. Our answer to the risk of a correlated sell-off in bonds and equities is to hold options to protect against rising bond yields and falling equity prices.”
Katy Thorneycroft, co-manager of JPMorgan Multi-Asset Trust plc said: “We expect US policy rates to continue steadily tightening over coming quarters, but even then monetary policy will remain accommodative and supportive for risky assets into early 2019. Within asset classes, we have a preference for US stocks over most other regions. We are more cautious on emerging markets and we see further headwinds from trade tensions, a stronger US dollar and rising US rates. We continue to see opportunities for returns and diversification within infrastructure.”
Peter Elston, chief investment officer of Seneca Global Income & Growth said: “We started reducing Seneca Global Income & Growth’s equity exposure some time ago from an overweight position and we are now quite underweight. We’ll continue to move further underweight over the next year or two, as the cycle matures.”
Performance
Hamish Baillie, investment director at Ruffer Investment Company said: “We have the benefit (or should that be the burden of expectation) that accompanies a long track record having experienced two bear markets. Typically, our strategy will underperform in the latter stages of a bull market (as was the case in 1999 at the height of the tech bubble and from mid-2006 to early 2007 before the financial crisis) but it comes into its own at inflection points. We have a good record of performing in a downturn and then capitalising on that when the market bottoms and starts to recover. Ideally, we would like to produce steady positive returns regardless of the direction of the market. Of course, no economic downturn is the same as the last one and so the investment process and philosophy is more important than the track record.”
Peter Elston, chief investment officer of Seneca Global Income & Growth said: “Seneca Global Income & Growth’s performance comes from four sources: long-term exposure to various asset classes, tactical variations to these long-term exposures, investment in a concentrated portfolio of undervalued opportunities across key asset classes, and borrowing. Our modelling suggests these can combine to produce a real return of 6% over a typical cycle.”
"We have a good record of performing in a downturn and then capitalising on that when the market bottoms and starts to recover. Ideally, we would like to produce steady positive returns regardless of the direction of the market."
Hamish Baillie, investment director at Ruffer Investment Company
From Brexit and the high street to social housing
Investment companies discuss prospects for property
With assets totalling £19.8bn and 22 new launches over the past five years, property has been one of the fastest growing areas of the investment company industry.
Across the five property sectors investment companies give investors access to a wide variety of different property types, ranging from office buildings and shopping malls to social housing, residential housing, healthcare and ‘big box’ logistics warehouses.
On Monday 5 November the Association of Investment Companies (AIC) held a media roundtable on property. Max Shenkman, partner at Triple Point Investment Management, which manages Triple Point Social Housing REIT, Calum Bruce, investment manager of Ediston Property and Richard Shepherd-Cross, fund manager of Custodian REIT, discussed the impact of Brexit, where they are finding opportunities and risks, and the outlook for the sector.
Their views have been collated below alongside those of Stephen J Inglis, chief executive officer of London & Scottish Investments which manages Regional REIT, and Andrew Cowley, managing partner of Impact Health Partners which manages Impact Healthcare REIT.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies said: “The closed-ended structure makes investment companies particularly well suited to investing in illiquid assets like property and this was highlighted by the problems the open-ended property companies suffered following the Brexit vote. During this period, closed-ended property companies continued to trade and their managers were not forced to sell assets. This meant that despite discounts widening, the closed-ended managers could continue to take a long-term view of the property market.
“The greater suitablilty of the investment company structure is also demonstrated by their substantial outperformance and higher yields."
Annabel Brodie-Smith, Communications Director, The Association of Investment Companies
“The greater suitablilty of the investment company structure is also demonstrated by their substantial outperformance and higher yields. Recent research by Canaccord Genuity found the average dividend yield of UK commercial property investment companies is 5.3% versus an average of 3% for heavyweight open-ended funds. Performance over the past ten years has also been considerably better: the annualised NAV and shareholder returns of UK commercial property investment companies were 7% and 10.9% versus 4.3% for equivalent open-ended funds. These outcomes may well be due to Canaccord Genuity’s finding that the average direct property exposure of the investment companies is 131% of NAV versus 78% for the open-ended funds.”
"The closed-ended structure makes investment companies particularly well suited to investing in illiquid assets like property and this was highlighted by the problems the open-ended property companies suffered following the Brexit vote"
Annabel Brodie-Smith, Communications Director, The Association of Investment Companies
Impact of Brexit
Richard Shepherd-Cross, fund manager of Custodian REIT said: “Brexit is having much less of an impact than the pundits predicted. In the three months post the EU referendum the market took a hit but also fully recovered and has pushed on since then. There is no question that the uncertainty of the outcome of Brexit negotiations is creating some disquiet, but the day-to-day pressures of a normal property cycle are still having a much greater impact on the market. We do not believe that anyone is forecasting a wide-scale collapse of businesses leading to tenant default post-Brexit, so income returns from property should be robust.
“A more realistic and measured forecast is that domestic demand from occupiers for regional property will be broadly consistent pre- and post-Brexit and the current pressures on rents from demand, development costs and supply will also remain. In London we have witnessed a continued demand for investment property from overseas investors which bodes well for the post-Brexit market. If we experience volatility post-Brexit we believe that investors may be better served being invested in a well diversified, UK regional property portfolio with a focus on dividend income investments that are more closely linked to the wider financial market.”
Calum Bruce, investment manager of Ediston Property said: “There is no consensus view as to what will happen, but it is likely that there will be a pause and more subdued property market activity. This occurred immediately after the EU referendum in 2016, when investors and tenants alike considered the uncertainties of Brexit. This was exacerbated by the liquidity problems faced by the daily dealt open-ended real estate vehicles, many of which were forced to close to manage redemptions and sell assets to increase cash levels.
“With Brexit on the horizon there will be challenges ahead and Central London offices remain the most vulnerable sector. However, in an uncertain market where investors adopt different stances on key issues, there will be opportunities to exploit.”
Max Shenkman, partner at Triple Point Investment Management, which manages Triple Point Social Housing REIT said: “Our growing sector has inflation-linked, long-term leases and when coupled with the long-term demand/supply fundamentals. This helps to make this sector more resilient to economic downturns and turmoil, including ongoing challenges with Brexit.”
"Brexit is having much less of an impact than the pundits predicted. In the three months post the EU referendum the market took a hit but also fully recovered and has pushed on since then"
Richard Shepherd-Cross, fund manager of Custodian REIT
Opportunities and risks for property
Calum Bruce, investment manager of Ediston Property said: “Care must be taken to identify those assets which have the right fundamentals to best deliver good performance for our shareholders. We don’t like investing in high street or shopping centre assets and think industrial is too expensive. There is some opportunity in the regional office markets and retail warehouse yields look attractive relative to the other sectors. However, stock selection is key. We have an intensive approach to asset management and continue to unlock opportunities within the portfolio which protect and improve income as well as increasing the capital value of our properties.”
Andrew Cowley, managing partner of Impact Health Partners which manages Impact Healthcare REIT said: “We selectively acquire, renovate, extend and redevelop high quality healthcare real estate assets in the UK, in particular residential care homes, and lease those assets primarily to healthcare operators providing residential healthcare services under full repairing and insuring leases.
“Our tenants have a good track record of providing quality care and are responsible for maintaining homes and have committed to a minimum level of expenditure per bed on maintenance annually, rising with RPI. Potential investments must meet these requirements and our strict investment criteria, rigorous due diligence and return profile are expected to deliver further value for our shareholders.”
Stephen J Inglis, chief executive officer of London & Scottish Investments which manages Regional REIT said: “We have bought and sold in excess of £350m of properties over the past 12 to 18 months. We continue to see good opportunities in our core sectors, regional offices and industrial assets, and continue to employ our active asset management initiatives to generate a number of successful lettings and renewals across the portfolio.
“We are a long-term investor and we focus on income, which is derived from a wide number and spread of tenants in the sector. In addition, we have undertaken a number of debt refinances over the past couple of years, and our average debt expiry is in the region of seven years with loan to value having been managed down to circa 40%. As such, all of our debt is fixed or hedged and we therefore have a minimal risk to any interest rate movements. We believe that this makes us much more resilient than many other REITs in the commercial property sector”.
Max Shenkman, partner at Triple Point Investment Management, which manages Triple Point Social Housing REIT said: “We invest primarily in newly developed/refurbished social housing assets in the UK, with a particular focus on supported housing properties which have been adapted for vulnerable tenants with care and support needs. The group focuses on making off-market investments that are subject to inflation-adjusted, long-term (typically from 20 years to 30 years), fully repairing and insuring leases with Registered Providers. The vulnerable tenants housed in the properties we own are typically in receipt of housing benefit for the full value of their rent and this is ultimately funded by the Department of Work and Pensions.
“In addition to acquiring recently completed properties we also forward fund developments that are pre-let to Registered Providers, but we don’t directly or speculatively develop. Forward funding gives us access to high quality assets that have been designed in conjunction with Registered Providers and local authorities, with whom we work closely, to meet specified local demand, providing a competitive advantage over our peers.”
Outlook for property
Andrew Cowley, managing partner of Impact Health Partners which manages Impact Healthcare REIT said: “The number of people aged over 85 in the UK is forecast to double to 3.2 million from 2016 to 2040. In 2018, 14.7% of the over 85s required the kind of care which can only be provided in a residential care home or hospital. From its peak in 1996, the UK has seen beds declining 17% to 466,000 beds in 2018. Over that period, there was a major shift from beds provided by government entities to beds provided by independent operators. As a result, the independent sector has experienced sustained, above-inflation growth. The fundamentals of our market are strong, with growing demand for beds and limited supply.”
Max Shenkman, partner at Triple Point Investment Management, which manages Triple Point Social Housing REIT said: “The undersupply of supported housing is stark and government grant funding continues to be insufficient to meet growing demand. Demand for supported housing is increasing due to improvements in healthcare and the arrival of the Care Act 2014, which placed a statutory obligation on local authorities to house people needing care in independent living situations based in communities where possible. Supported housing assets also often offer local authorities better value for money when compared to traditional alternative forms of accommodation.
“The mismatch between supply and demand is forecast to increase over time, which leaves us continuing to be confident for the long-term prospects and growth of the sector. Through our strong established network, we currently have access to an identified pipeline of over £400 million of potential investments that meet our investment criteria and on attractive terms.”
Richard Shepherd-Cross, fund manager of Custodian REIT said: “There is a market flight from retail investment. We believe it is too simplistic to write off an entire sector and expect to see opportunities in good quality out of town retail. For the most part, we would need to see a cooling in investor demand for industrial/logistics before it represented fair value to Custodian REIT. However, the lack of development in smaller unit sized office and industrial in regional markets, combined with very high levels of employment should maintain the existing supply/demand imbalance that is producing rental growth. Out of this we expect to see investment opportunities in these sectors.”
Calum Bruce, investment manager of Ediston Property said: “The greatest issues have been on the high street and in shopping centres with many of the store closures occurring in these locations. We don’t invest in the first two sectors but see more opportunity in retail warehouses. Yields look attractive relative to other sectors and we continue to see good tenant demand for retail parks which are well-located, have the right planning consents and are let off sensible rental levels. With a number of deals in the pipeline we don’t see this trend changing as the year progresses.”
"The greatest issues have been on the high street and in shopping centres with many of the store closures occurring in these locations"
Calum Bruce, investment manager of Ediston Property
Paying the rent
Ian Cowie examines the advantages of investment companies in the property sector
Ian Cowie
Income-seeking investors should consider above average yields - that is, dividends expressed as a percentage of share price - available from the rents paid in commercial property sectors. For example, while most types of investment trust yield an average of about 3.3%, investors can obtain nearly two thirds more income from the Association of Investment Companies (AIC) Property Direct UK sector, where the average yield is 5.2%.
Pooled funds - such as investment trusts or unit trusts - enable individual investors of all sizes to participate in commercial property, despite the fact that individual office blocks, factories, shopping malls and warehouses may each cost millions of pounds. Pooled funds, as their name suggests, bring together many investors’ money to share the cost of acquiring commercial property and the expense of improving and maintaining these assets, which would otherwise be beyond the pockets of all but the richest individuals.
"For example, while most types of investment trust yield an average of about 3.3%, investors can obtain nearly two thirds more income from the Association of Investment Companies (AIC) Property Direct UK sector"
However, higher rewards in the form of above-average yields may be accompanied by higher risks - and some of these are less obvious than others. One danger is disruptive technology or the growing popularity of shopping online which has rendered some retailers less competitive and hit the capital values of associated forms of property, such as some shops. British Home Stores and Woolworths were among the best-known brands on the high street before these ‘bricks and mortar’ shops were forced out of business by new competition, including ‘clicks and mortar’ internet retailers, such as Amazon and Google. Even household names including Debenhams, House of Fraser and Marks & Spencer have been forced to close some stores recently.
Professional fund managers seek to minimise risks and maximise returns from commercial property by selecting assets which can deliver rental income and preserve capital values. For example, Calum Bruce, investment manager of Ediston Property Investment Company, said: “The retail market is facing a number of challenges but it is important to distinguish between high street, shopping centres and retail warehouses.
“The first two sub-sectors will be hardest hit and the current high vacancy rate will trend even higher. Our company has no exposure to these two sub-sectors. However, the retail warehouse vacancy rate is at its lowest level ever at about 4.5%.”
Strong demand for warehouses needed to distribute goods bought online underpins the capital value of these properties and the rental income they generate, which contributes to Ediston’s 5.5% dividend yield. Foreign & Colonial Commercial Property, is another fund in this sector - with widely-diversified total assets of more than £1.3bn - and a yield of 4.4%. Both these funds distribute dividends monthly, which can be useful for investors whose priority is income.
More focussed exposure to specific aspects of real estate can be obtained through funds in the AIC Property Specialist sector. As their names suggest, Empiric Student Property and GCP Student Living set out to serve the need for accommodation at universities and generate dividend yields of 5.3% and 4% respectively. Similarly, Impact Healthcare Real Estate Investment Trust (REIT) and Primary Health Properties provide some of the buildings required by the National Health Service and generate yields of 5.8% and 4.9% respectively. Another option in this sector is Triple Point Social Housing REIT which provides accommodation for people with special needs, often funded by housing associations, and currently yields 3.6%. Investors seeking specific geographical exposure to commercial property can also consider AIC sectors such as Property Direct - Asia Pacific and Property Direct - Europe.
In all the above cases, investment trusts’ closed-end structure gives them and their shareholders an important advantage over investors in other forms of pooled funds, such as unit trusts or open-ended investment companies (OEICs). Commercial properties tend to be ‘big ticket’ assets where the price of a single factory, office block, or warehouse will often run into several million pounds. That is why these properties are sometimes described as “illiquid assets”. It can be difficult to turn them into cash or even to put a realistic value on what they might fetch, particularly during periods of rising anxiety and falling prices. During such periods of market uncertainty and volatility, open-ended pooled funds such as unit trusts and OEICs have been forced to suspend trading, preventing individual investors from getting back into cash, until calmer conditions prevailed.
Even in more normal circumstances, open-ended commercial property funds often hold more than a fifth of their assets in cash in order to maintain sufficient liquidity to meet redemptions by unit-holders.
By contrast, closed-end commercial property funds have no need to maintain substantial cash holdings to meet redemptions by investors because the price at which their shares trade on the stock market will reflect variations in demand, without any need to sell underlying assets. These investment trusts’ share prices may rise and fall and their discounts to net asset value (NAV) may narrow and widen but their fund managers should not be forced to sell in order to raise cash. That may sound like a technical difference between closed-end and open-ended pooled funds but it gives the former a substantial advantage over the latter, which is particularly important when managing inherently illiquid assets, such as commercial property. These factors also explain why commercial property investment trusts tend to offer higher yields than their open-ended rivals and, with very few exceptions, have delivered higher total returns over the last year, five and 10-year periods. No wonder the City regulators are consulting on how open-ended commercial property funds can protect the interests of unit holders and address structural problems with liquidity - or their ability to let investors get back into cash.
You might not think that liquidity would be a problem in a sector such as commercial property where rental yields supply a stream of income. But the value or price of any asset is ultimately determined by what someone is prepared to pay for it. Or, as city cynics sometimes say, revenues are vanity, profits are sanity but cash is reality.
