Over recent years property has gone from being one of the most hated asset classes, following the large losses seen during the financial crisis, to one of the most popular with property funds making gains approaching 20 per cent over the past year.
Performance of sectors vs index over 1yr
Source: FE Analytics
Figures released by the Investment Association last week revealed that property funds were the best-selling sector last month with net retail sales of £304m. The sector had been the second best seller in pretty much every month of the last year.
In stark contrast, equity saw negative net retail sales for the second consecutive month in February with an outflow of £59m.
But for many investors, it’s a worry when a sector become too popular, as buying what is hot at the moment is rarely a sound long-term investment strategy.
Whitechurch Securities recently said it remains favourable on UK commercial property, following recent positive gains. The discretionary manager added that it likes property as an alternative to holding gilts.
“However, we are aware of the increasing popularity of the asset class,” the management team added, “which may make it more difficult for funds to get monies invested. We are sanguine about the situation at the moment but continue to keep inflows into the asset class under close scrutiny.”
The immediate alternative to the popular open-ended property funds would be to invest in close-ended property trusts, which are unaffected by asset flows.
Many people believe that open-ended property funds aren’t the best structure for the asset class, despite their popularity, because of the potential liquidity property that could be encountered.
On the other hand, the average UK direct property trust is currently trading on a 9.6 per cent premium, which means that shares are valued at nearly 10 per cent more than the underlying assets are worth.
So, is it better to buy a product that isn’t suited to property investing or buy one that is but is expensive? Or, in light of its growing popularity, is it wise to leave the property sector alone completely?
Simon Evan-Cook (pictured), senior multi-asset manager at Premier, believes that there is still plenty of opportunity in the sector, but acknowledges that there are drawbacks to both types of investments.
“The immediate downside with open-ended funds is that you’ve got a relatively higher cash weighting so you’re not getting the full benefit of what property is doing, how it’s re-rating, the rental growth and the rental income you’re achieving,” he said.
“If you hold investment trusts you can get nice high yields, but then you’ve also got higher volatility as the price moves on a daily basis.”
Martin Bamford, managing director and financial planner at Informed Choice, believes that the pros associated with investing through both open-ended and closed-ended funds outweigh the cons.
“As long as open-ended property funds hold a sufficient cash balance to meet liquidity demands, these are not a bad way of accessing the asset class,” he explained.
“Using a closed-ended property fund instead replaces liquidity risk with the risk you will need to sell your holding at a deep discount during times of market turmoil.”
“For long-term investors, thinking about getting out of the fund should not be a big concern, as they should be prepared to remain invested for the long term and pick a suitable time to disinvest their holdings.”
Scott Gallacher, director and financial planner of Rowley Turton, believes that it depends on how strong the stomach of the investor is in terms of volatility and remaining invested over a long time period.
He said: “If you compare the Standard Life Investments UK Property fund and the Standard Life Investments Property Income Trust, the ups and downs are frighteningly different.”
“Part of this difference is the result of discounts on the investment trust during the crash and premiums during good times. These have the effect of amplifying the losses or profits on investment trusts.”
As shown in the graph below, while the fund has achieved a consistently smoother ride since both of the funds were launched, the trust has outperformed.
Performance of fund vs trust since launch
Source: FE Analytics
“It’s worth pointing out that the total extra performance difference between these two funds is just 16 percentage points ,which has come about in the last six months,” Gallacher added. “Should the fund come off its 16.56 per cent premium, then all of that extra performance would disappear.”
Meera Hearnden, senior investment manager at Parmenion, prefers open-ended funds when investing in property.
She said: “We generally prefer the bricks and mortar funds that are in the open-ended structure. While these can be less liquid than other assets, they benefit from low volatility compared to equities for example and offer diversification away from other assets as well as a reasonably stable income.”
“Closed-ended structures like investment trusts can carry additional risks such as the underlying portfolio investing in equities. This reduces the level of diversification an investor potentially has. Additionally, gearing can increase risk.”
Property funds that Parmenion currently invest in include L&G UK Property, Ignis UK Property and Threadneedle UK Property.
“The latter invests in secondary property while the two former funds invest more in prime and in London and the south-east, offering broad diversification across the asset class,” Hearnden explained.
Adopting a different approach, Premier’s multi-asset funds use a blend of both open-ended and closed-ended property funds in their portfolios to minimise risk. However, the increasing popularity of the sector is something that Evan-Cook and his team are keeping a close eye on.
“We think that having the two together in a portfolio works quite well as a blend,” he said. “We are contrarian investors, so we are monitoring the sector’s popularity regularly.”
“At the moment it’s not something we’re overly concerned with – we still think there are plenty of people who are not buying open-ended property funds. Institutional investors or pension funds still seem to be underweight the asset class from what we can ascertain.”
“But it’s something that should pick up and carry on like this for a long time. We think valuations are attractive, certainly relative to equities and particularly bonds, but then that’s something we’d need to review and decide regularly.”
“If there’s no valuation support then that’s when we start to get concerned and we’ll reverse our position and come out.”
Despite Evan-Cook’s belief in blending both investment types in a portfolio, both Premier’s Multi-Asset Growth & Income and Multi-Asset Monthly Income funds predominantly hold open-ended property funds.
“We absolutely believe that open-ended property funds are still a good investment,” he added.
Evan Cook particularly likes the Threadneedle UK Property Trust, however, because it has a heavier weighting in secondary properties as opposed to prime properties.
He said: “Prime properties have had an extremely good run over the past five years, to the point where it looked a little bit expensive to us, whereas in the secondary sector you’re still able to get high yields and good valuations, so the risk/reward trade-off we think is better in that part of the market.”
“Understand where the investment manager is investing. If it’s purely in prime properties then you’re maybe not being paid for the valuation risk that you’re taking.”
“Otherwise, it just important to be prepared to be a long-term investor. Invest with a view to holding the asset for 10 years, not six months.”
