Property funds deserve a place in any long-term investor’s portfolio, Aberdeen’s Tim Sankey argues, as the asset class is one of the best ways of preventing their fortunes being too reliant on what happens in stock and bond markets. 
The first three quarters of 2015 have presented investors with a rocky ride, after concerns around the timing of US interest rate rises, slowing economic growth in China and the Greek debt crisis damaged investor sentiment.
FE Analytics shows that between the start of year and 30 September 2015 the FTSE All Share lost 2.86 per cent in total return terms while UK government bonds, represented by the Barclays Sterling Gilts index, rose just 1.85 per cent. Both indices went through a volatile ride over this period.
But Sankey – a fund manager in Aberdeen Asset Management’s direct property investment team – points out that property funds offer investors valuable diversification, as shown in the below graph.
The blue line shows the outcome of the average ‘bricks and mortar’ IA Property fund during 2015’s first nine months; not only is the return higher than those for stocks and gilts, but investors have been put through far fewer ups and downs in the process.
Performance of indices and sector over 2015
Source: FE Analytics, bid-to-bid performance with dividends reinvested between 1 Jan 2015 and 30 Sep 2015
Sankey said: “The value of property really came home to me over the summer when I was watching the equity market do what it did in August and you reflect that fixed income valuations are at their highest ever levels.”
“There’s a strength to investing in property and real assets. Property brings diversification to a portfolio. Over the long term, the correlation between property and fixed income is zero, while it’s pretty low with equities over any reasonable period of time.”
The above example is over a very short time frame to show how the asset class held up over a turbulent period, but the manager stresses the need for property investors to take a long-term view.
“My concern is that investors too often look to property for short-term returns,” he said, adding that the highly cyclical nature of the asset class – meaning its outcome is heavily dependent on conditions in the underlying economy – means an investment should be made over a multi-year time frame.
“Too often investors have had a bad experience from property by investing at the wrong point of the cycle or on a short-term basis. They should look more at the long term.”
However, Sankey says that the Aberdeen Property Trust, which he runs with Gerry Ferguson and James McLean, places a lot of emphasis on avoiding these “bad experiences” by putting risk management at the heart of the open-ended fund’s process. A key element of this is searching for properties with reliable, repeatable income streams.
“The overriding issue is that investors in property don’t tend to think enough about risk. Central to the way we manage the trust is a focus on risk management,” he said.
“Our whole structure is about risk management: thinking about market pricing in a long-term context and applying the right level of risk for the market conditions and knowing when to take risk off the table then when to put it back on again.”
“Our strategy is nothing to do with a benchmark or sector allocations, it’s purely thinking about risk and that allows us to give investors long-term performance and confidence that their capital is safe.”
This might mean that the £3.6bn fund looks “incredibly boring” – which is exactly how the managers want it to be. Given their view that property pricing appears to be “fairly raised”, the team has been de-risking the portfolio.
For example, the fund disposed of two office developments – one in Heathrow and the other in Manchester – as while they were “exciting prime opportunities”, development is the highest risk property investment. The two holdings were sold at premiums of more than 30 per cent whilst meeting the strategic objective.
The manager adds that the traditional core commercial property markets of offices, retail parks and shops are “crowded” meaning pricing has been pushed up. While he says that this part of the market will become attractive again at some point in the future, right now the team is seeing opportunities elsewhere.
“We’re not saying we’re at the top of the cycle but looking at pricing on a long-term basis it is above what we think is sustainable,” Sankey said. “We’ve de-risked our portfolio and sold out of a number of high-risk assets in the last nine months.”
This has comes alongside some acquisitions that the team deem to be lower risk but still offer long-term repeatable income – a key feature the managers look for in any of their investments. This year has seen the fund buy a supermarket in Reading with a long lease to Morrisons as well as opportunities in the residential space.
“At the other end of the scale, we invested in some residential assets in Stratford, where the average lease length is six months. But there’s massive diversification of income through its 200 units and occupancy rates have been over 99 per cent so it might have very short leases but vacancy periods can be as low as a day and we can grow the income over time.”
FE Analytics shows Aberdeen Property Trust has returned more than its average peer over one, three and five years to the end of September 2015. Over three years, for example, it’s up 33.66 per cent while the average member of the IA Property sector posted a 25.23 per cent total return.
Performance of fund vs sector over 3yrs
Source: FE Analytics, bid-to-bid performance with dividends reinvested over three years to 30 Sep 2015
The fund also compares favourably with its peers on other risk-management metrics; our data shows it is in the peer group’s top quartile when it comes to annualised volatility, downside risk and maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – over the past five years.
The value of investments and the income from them can go down as well as up and your clients may get back less than the amount invested.