The flood of retail money going into commercial property funds is a cause for concern, according to F&C’s Gary Potter, who cautions investors to remember the devastating losses that hit the asset class at the peak of the financial crisis. 
Figures from the Investment Association show that the IA Property sector has taken in £3.7bn in fresh retail money over the past year and has frequently been one of the bestselling peer groups on a monthly basis.
According to FE Analytics, the three most popular funds over this time have been Henderson UK Property, M&G Property Portfolio and L&G UK Property.
Meanwhile the average trust in the Association of Investment Companies’ Property Direct UK sector is sitting on an 8.4 per cent premium, reflecting investor demand for the asset class.
F&C Commercial Property is on the highest premium at 15.7 per cent, followed by the Standard Life Investments Property Income and UK Commercial Property trusts.
Inflows into IA Property funds over 2015
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Source: Investment Association
Potter (pictured), who heads up F&C’s multi-manager range with Rob Burdett, agrees that property has many attractions as an asset class but is worried by the number of retail investors following the herd into a popular trade.
“Frankly I’m staggered – and I know that’s a strong word – by the euphoria that’s surrounding property once again. I think there are some good opportunities in property but if you look at what happened the last time you had this much cash going into commercial property funds, it wasn’t good. That really scares me,” he said.
“I just wonder why people don’t think more about what happened in 2008 with the large retail-focused property funds. Now you’re getting potential cash drags and ever larger properties being purchased because the funds are so much bigger.”
“What’s property really about? It’s about longstanding, sensible total return supported by yield that can gradually improve over time. What we’ve had is the opposite – euphoria and prices, especially for property trusts, have taken off.”
“I think people have forgotten the not-too-distant memory of 2008 when property funds generally fell 40 per cent. I’m not suggesting for one minute that the economic conditions akin to 2008. But what I am suggesting is that the elastic has been stretched too far between price and fundamentals here.”
Over the course of the financial crisis, property was hit much harder than UK or international equities, as the graph on the following page shows. The asset class was also much slower to recover and investor sentiment has only turned in its favour over recent years.
Performance of sector vs induces between 2007 and 2009
Source: FE Analytics
During the crisis, the average IA Property fund suffered a maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – of just under 50 per cent; the FTSE All Share’s was 41.09 per cent while it was only 33.21 per cent for the MSCI World.
Potter said: “I’m not trying to be negative on property. I think it has a lot of positive attributes, particularly in a rising inflation environment. But the only thing that determines how good an investor you are is the price you pay for an asset and it does seem that some people are ignoring the fundamentals and paying anything to secure a property. It’s just getting a bit mad.”
“I use a Monopoly board to describe what we’re thinking. Everyone would like to own Mayfair and put a couple of hotels on there but I think Mayfair property – and London commercial property in general – is becoming relatively expensive. What I want to own on a Monopoly board is the train stations and the electric and water companies, where things aren’t as frothy.”
F&C’s multi-manager funds are “marginally underweight” property. Exposure to the asset class is taken through smaller funds and property proxies, as Potter and Burdett believe this is the most “careful and sensible” strategy.
In terms of ‘conventional’ property funds, the multi-managers have a position in F&C UK Property, which is a £251.4m bricks and mortar commercial property portfolio managed by Guy Glover and Julian Smith.
The fund has just 9.5 per cent of assets in London property, with 37.4 per cent in the south-east region and 13.6 per cent in the west midlands. There’s also a 12 per cent allocation to the south-west and 11.1 per cent to Scotland.
F&C UK Property has returned 22.50 per cent since launch in June 2010, compared with a 42.76 per cent average return from the average IA Property fund. However, it must be noted that the sector’s returns are pushed up by the presence of property shares funds, which offer higher returns but equity-like volatility.
Performance of funds over 4yrs
Source: FE Analytics
Potter also highlights the Darwin Leisure fund as another holding that he believes could avoid many of the potential pitfalls highlighted above.
The £350m fund only invests in UK holiday parks, offering diversification away from the London commercial property dominating many portfolios. Given its investment focus, many of the fund’s holdings are in areas such as Cornwall, Kent, North Wales and the Isle of Wight.
The Guernsey-domiciled fund is ranked first quartile in the offshore Property Europe sector and is first quartile over three and five years. It has posted a 90.93 per cent total return over five years, while its average peer is up just 22.99 per cent.
GCP Infrastructure Investments is another way the F&C multi-manager team is taking property-like exposure. This £959.8m trust focuses on the debt issued by UK infrastructure project companies, typically investing in completed infrastructure projects with long term, public sector-backed, availability-based revenues.
This means the fund is invested outside of the office, retail and industrial properties that conventional real estate portfolios hold. Its portfolio currently has holdings in biomass, rooftop solar, private finance initiative, onshore wind and anaerobic digestion projects.
Since launch in July 2010 the trust has made a 50.91 per cent total return, underperforming the IT Infrastructure sector average but demonstrating some of the peer’s group best capital preservation metrics such as maximum drawdown and downside risk.
