Active managers have often found the ‘notoriously tough’ Australian real estate investment trust (A-REIT) market difficult to navigate, with its low stock count and excessive concentration of major stocks in the benchmark.
The “lemon has been squeezed pretty hard” in the last 10 years, as fund managers hunted for yield and quantitative easing sent a wave of money flowing into investment markets, much of it passive, driving risk assets higher as interest rates have fallen, says Zenith Investment Partners researcher, head of property and listed strategies, Dugald Higgins.
“This has often resulted in a paradox where low-quality/high-yield REITs can post strong returns,” Higgins says. “Active managers will frequently have a bias towards higher quality stocks that display characteristics such as sustainable cash flows, lower leverage, strong returns on invested capital and robust management.”
As the rising tide has lifted all boats, active managers like Renaissance Property Securities – which includes small-cap stocks in their investable universe – position their portfolios away from the benchmark as they look to produce excess returns.
Renaissance, which has managed the Zurich Investments Australian Property Securities Fund for the last 12 years, has outperformed the benchmark by taking significant positions away from the index in under-owned and under-researched small-cap assets.
“For a number of years – up until 2016 – A-REIT returns were in a rosy environment and index returns were pretty high. Particularly in that environment, excess returns can be a bit less meaningful,” Zurich investment specialist Charles Stodart says. “But when you have a high single-digit index return environment, excess returns that a good active manager can deliver become more valuable.
Zurich began its partnership with Renaissance based on the manager’s sole focus on A-REITs and the experience of the Renaissance team, led by Carlos Cocaro and Damien Barrack.
Investment firms with allocations to A-REITs and Global-REITs typically include generalists, Stodart says, who tend to focus on larger capitalised trusts.
“The [Zurich] fund is a sub $300 million fund and can include a portfolio of smaller-cap names. If you’re a large-cap manager that has $7 billion under management, you’re really unable to play in the smaller-cap space. Being nimble, you’re able to adjust sizes more quickly,” Stodart explains. “Cocaro and Barrack just really want to have the opportunity to look at smaller caps, but they’re not a small-cap manager and they’re actually now tending towards a neutral stance to smaller caps.”
RETAIL IN FAVOUR
While the Zurich fund has exposures to all the main sectors – office, retail, logistics – the managers have found hidden value in some sub-sectors, including suburban office and regional retail and residential managers.
The fund has recently taken advantage of a return to favour for larger retail trusts by reversing from an underweight position in Westfield Corporation in July 2017 after almost a decade, ahead of the Lowy family announcement that it would sell to French property giant Unibail-Rodamco for $32.7 billion in December.
One of the biggest changes recently for the fund has been its approach to retail, Stodart says.
“It’s a big part of the index and for a long period these names were quite highly valued,” he says.
“They weren’t attractive to Renaissance because they didn’t see value in being overweight those names. But what we’ve seen the last 12-18 months is that they’re turning more positive and part of that is driven by a contrary view to retail, especially the big retail malls, which have [had] subdued sales growth in the past 18 months, which has caused the market to treat them quite negatively.”
Renaissance has taken the view that retail sector headwinds are mainly cyclical and people have become overly concerned about the structural impact of online retail, like Amazon, which has caused some retail stocks to become oversold.
Meanwhile, suburban office names such as GDI Property and Australian Unity Office were high-quality managers whose value the market did not recognise, as many suburban office managers were benefiting from a spillover to more affordable areas from high CBD rents.
The fund has been quick to recognise such improvement in rental growth in Sydney’s CBD, where A-REITs in general have 60 per cent of their office exposure.
“Vacancy in Sydney office is now below 5 per cent, so (Renaissance) remain very constructive in that space,” Stodart says.
He adds that smaller residential has also been represented in the portfolio, with Renaissance preferring names less exposed to CBD apartment oversupply.
“Some of the smaller cap names they’ve found more interesting are Sunland Group and Villa World, although both have been reduced in the last few months, as they have outperformed,” he says.
Meanwhile, the fund is underweight childcare property managers because of unattractive valuations and worries about new supply.
Stodart says A-REITs provide a number of positive characteristics within a portfolio, with a relatively attractive yield of 5 per cent and earnings growth expected to be 4 per cent over the next few years.
Active management was vital for achieving this, Stodart emphasises.
“There are clearly good managers in the A-REITs space, though we believe that the experience of the Renaissance team, their value approach and their ability to look for value in smaller-cap names sets them apart from peers,” Stodart says.
A-REIT allocations are a valid and worthy addition to a portfolio to add diversification and income, Catapult Wealth director and financial planner Tony Catt says.
Catt says he expects the hunt for yield to continue in Australia because he believes the Reserve Bank is unlikely to lift interest rates for another one or two years.
“Investing in good quality property is still very important for my clients,” he says.
Something on his clients’ minds – both workers and retirees – was the ALP’s proposal to drop cash refunds for excess dividend imputation credits.
“If [the Australian Labor Party] are elected, that would create a huge tilt towards property trusts, as people getting typical franked income of 4 per cent to 5 per cent look to replace that income with a potential 7 per cent pre-tax listed property trust return,” Catt explains.
Meanwhile, the Reserve Bank’s potential to keep interest rates static while other central banks tighten could also lead to more international fund flows to A-REITs, Catt says.
Zenith’s Higgins says A-REITs have had a “reasonably tough” year, with returns for the S&P/ASX 300 A-REIT index returning an unspectacular 6.4 per cent to May 31, 2018.
With the US bond yield suddenly accelerating higher in February, the median manager failed to beat the sector benchmark, net of fees, and many of the top-quartile performers also failed to generate alpha, Higgins says.
“While we don’t do any form of market forecasting, fund managers obviously have a lot of issues they are grappling with going forward,” he says. “There are many factors at play, from the global macroeconomic and geopolitical issues to the changing demands of increasingly flexible workforces, technological advances and ecommerce.
“Some of the major issues, however, are obviously going to be determining the likely impact of rising risk-free rates on real estate markets [and by extension the A-REIT sector], as well as the impact of high levels of public, private and household debt in terms of being a drag on productivity and economic growth.”
Higgins sees greater opportunity for A-REIT managers to create value from mispricing as the impact of quantitative easing starts to be unwound globally.
TOPICS: AREITS, zurich, Zurich fund, Zurich Investments