Skip to the content

Can property really offer true diversification?

28 April 2017

FE Trustnet asks the experts whether property is a good option for investors looking for diversification in the portfolios.

By Jonathan Jones,

Reporter, FE Trustnet

True diversification is extremely difficult to find in the current climate and experts remain split on whether property can offer an investor true benefits.

It has been noted by media and among fund managers that bonds and equities – which traditionally have an inverse relationship – have been moving in the same direction for the last five years.

As the below graph shows, both the MSCI World and Barclays Global Aggregates indices were relatively flat from 2012 through to the start of last year before rising sharply in 2016.

Performance of indices over 5yrs

 

Source: FE Analytics

Toby Nangle, manager of the Threadneedle Global Multi Asset Income fund said: “Diversification sounds like a good thing to have – not all of your eggs in one basket – but from a portfolio construction perspective and from an investor’s perspective it is reliant on some finance principles working.

“It is the idea that you get to good places through different routes and if you have assets that are doing good things at different times then you ultimately end up with a smoother path to your objective.

“But diversification for diversification sake – that is saying I want to buy something different – is not really a hugely valid idea. They need to be adding something to you.”

One area investors have been considering is property: though the sector took a knock last year as many funds gated following the Brexit referendum when investors feared property prices may crash.

Twelve months on however, property prices remain robust, begging the question of whether exposure should be increased.

Nangle said: “A pretty big question for investors right now is ‘are we in a regime where bonds and equities are increasingly correlated’?

“My personal answer is that we are much more likely to be in a positive correlation regime and it is more likely that yields rise causing the bond prices to fall at the same time that equities fall.”

For those looking at property for diversification, Nangle says the asset class will offer something different. However, he notes that it still shares links with other assets and, as was proven last year, has issues of its own.


He said: “It is a different asset class, it doesn’t integrate perfectly with other things however there are liquidity issues with investing – you can’t dip in and out – and there’s high entry/exit charges which means that investors tend to have longer term views on things.

“Should you take comfort from the fact that it doesn’t go up or down every month like other things?

“Well only to a certain degree because it doesn’t show a very volatile price path because you’re not going in and out every month that you might get false comfort from the diversification that is offered.”

He added “If ultimately your investment view is that bond yields will rise, credit spreads will rise, defaults will rise and liquidity premiums will increase then you don’t get any comfort from property.

“If your view is that we are at a relatively equilibrium kind of place right now then does having property do something to enhance the diversification of your portfolio?

“Well, yes, there are things that will affect property and not other assets and this means that there is some diversification behind it.”

However, he says tenants, who are part of the real economy and impacted by other factors, mean the asset class is linked to other factors.

“We saw in 2007 when there were blows to the real economy [and] that property is far from immune from it. We’ve seen in the rallies from 2012 to 2015 that wasn’t driven by an increase in the fundamental attractiveness but the relative valuation of property versus other assets so there is some integration there,” Nangle said.

Performance of indices over 5yrs

 

Source: FE Analytics

Indeed, while the IPD UK All Property index has moved slightly differently to equities, the return is almost identical – with just 65 basis points difference – over the last five years.

An option for investors not willing to tie their cash into physical property is property equity securities which Bill McQuaker uses in his Fidelity’s multi-asset Open range.


He says it is the notion of soft equity meaning that when equities perform well in a rising market, the probability is that property securities underperform, but in a more difficult environment, particularly one where bond yields are falling, property equity securities will outperform equities.

“Through the cycle I would expect it to do a bit worse. If you think equities are going to return 6 or 7 per cent then property might do 5 per cent,” the manager added.

“But nevertheless you have a somewhat different risk character from other equities and I like that as an addition to the mix.

“[The recent correlation between property and equities] has been driven by the re-rating of the bond market and the fact that bond yields have moved to very low levels and property equity securities definitely have a sensitivity to the level of bond yields.

McQuaker said: “In the context of the portfolios I run I don’t mind that because I’m quite underweight government bonds versus my peers so if I had a lot of property equity securities and I had a lot of government bonds at the same time I would worry that I was a bit overexposed to the risk of higher yields.

“Given that I don’t have the bonds I can take the risk in the equity space and not worry about it.”

However not everyone is convinced, and Thomas Miller Investment head of private client investment management in the UK Andrew Herberts says there is only one true diversifier: cash.

Performance of indices over 5yrs

 

Source: FE Analytics

“Actually cash fits a little bit to the whole alternatives story as what we’ve seen is huge correlation of assets on the way up including most alternatives and what we’ve been thinking is if all these drivers come off and are correlated on the way down then where do we get our protection,” he said.

“I think a lot of managers are going fairly blindly into alternatives, looking at very historical relationships and ignoring what has happened in the last year or so.

“For us cash is a zero correlation asset but it’s never a strategic asset as much as a tactical asset. It’s the ultimate resilience asset.”

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.