A multimanager approach to investment has grown in popularity in recent years. The benefits include spreading risk across different managers and strategies, greater flexibility and ease of administration. Dr Guy Morrell, Head of Real Estate Multimanager (UK) maintains that the arguments for adopting such an approach to global property are even more compelling, largely due to the inherent characteristics of property as an asset class.
Be wary of home bias
Commercial property has proved a popular asset class in recent years. The Investment Management Association reported that 2006 net inflows to commercial property funds rose by 320% above the previous year’s level. Most of the retail investment into commercial property has been directed to the UK.
UK property prices have grown rapidly in recent years, fuelled in part by these strong net cash inflows. This strong price growth, however, has depressed market yields. Initial yields (the ratio of current net rental income to capital values) fell from 7.1% to 4.6% over the five years to September 2007.
However, while the UK is one of the most established, transparent and liquid real estate markets in the world, prospective returns have diminished and the market has started to weaken. The capital return recorded by the IPD Monthly Index turned negative in July 2007 and, over the three months to the end of September, capital values fell by 2.2%, dragging total returns to -1.0%. This represented the first negative quarterly total return since November 1992. In our view yields will have to rise further before the market represents fair value.
Time to consider global property
It is timely to consider opportunities outside the UK for two reasons. From a returns perspective, we believe there are better opportunities by expanding the investment universe. Property yields have fallen in many parts of the world and we expect prospective returns to be lower than those enjoyed in recent years. Nonetheless, relative to the UK, it should be possible to secure higher returns by taking a more global perspective. On relative return grounds, a more global approach is justified.
The second reason for considering a more global approach is for risk diversification. Real estate markets are not perfectly synchronised to each other. The demand for commercial floorspace is a function largely of economic activity, and economic cycles vary from country to country. Similarly, supply conditions vary between and within countries. Leasing terms and practices also differ. These factors contribute to poor correlation between property markets, offering the potential for reducing the overall volatility of returns.
The benefits of a fund of funds approach
Implementing a global strategy is not straightforward, however. Partly this reflects the nature of the asset class.
Assembling a direct property portfolio globally is beyond the scope of all but the largest investors. Commercial property is characterised by large expensive and lumpy assets. Diversifying asset specific risk is difficult. Specialist skills and local market knowledge are essential direct ownership confers control but also obligations.
Some vehicles available to UK investors offer access to global property but through listed property securities rather than owning physical assets. They offer the means to gain access to markets in a relatively liquid way. But listed property markets exhibit higher volatility than unlisted property and are more correlated to equity markets. Thus diversification benefits are weakened if a portfolio holds only listed property securities.
Another option is to purchase a fund that holds predominantly direct property. However the range of these funds, thus far, is limited and adopting such a strategy exposes investors to ‘single manager risk’. Moreover, it is difficult for any single manager to build up property expertise around the world.
Our preferred approach for global property investment is through a fund of funds. The HSBC Open Global Property Fund enables investors to obtain exposure both to funds that hold predominantly direct property, and also listed property securities. It offers the following advantages;
- It enables managers to be selected with local expertise and presence
- It provides more effective diversification, with exposure to a larger underlying asset base than would otherwise be possible through investment in one fund
- A carefully assembled, efficient portfolio can be constructed taking account of the contrasting and complementary portfolios, strategies and management styles of underlying funds
- It diversifies single manager risk
- The fund of funds team can continually monitor and assess new vehicles as they become available, and review existing funds and their managers to ensure performance matches objectives.
Summary
A weakening domestic market means it is timely to consider opportunities outside the UK. The segmented nature of property returns and weak correlation between other assets classes means there are also potential risk reduction benefits from such a strategy. A fund of funds approach offers an attractive means of executing a well-diversified but focused global property strategy.
For more information on HSBC Open Global Property Fund visit http://www.hsbcinvestments.co.uk/openfunds or call 0800 181 890
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