Shayan Ratnasingam

Finding diversification beyond commercial property

Shayan Ratnasingam

Seeking diversification beyond equities and bonds has seen multi-asset investors turning to property funds to fulfil this role. Bricks and mortar’s easy-to-understand business model has obvious familiarity benefits, with many of us comfortable with the experience of owning a home, but recent years have provided ample evidence that open-ended property funds have serious shortcomings.

Beyond diversification, property can offer downside protection, benefiting from fundamentals that are resilient against broader market volatility. These include long-dated contracted cashflows via rental income and protection against inflation, with property often enjoying upward-only rent reviews linked to the Consumer or Retail Price Index (CPI or RPI).

Issues have largely come from the dichotomy between the retail market’s need for daily pricing and the liquidity profile of an illiquid asset class. A number of larger direct property funds have been forced to suspend trading as a result of heavy redemptions, leading to questions around this asset’s suitability as a retail investment.

Given high-profile issues with open-ended property funds, however, many investors are seeking replacements and we see several options that can provide similar benefits without the liquidity concerns, largely in the listed Real Asset space.

‘Real’ in this context can include tangible assets such as land, buildings, toll roads and energy generators (solar and wind farms), which derive value from their availability and usability. Many of these provide an independent and diversified return stream from equities and bonds, as well as that potential protection against inflation, capital preservation and attractive income, all characteristics that have traditionally attracted investors to property.

We access these areas, once reserved for institutional investors, via closed-ended vehicles, primarily investment trusts, which are able to own less liquid assets without the fund-flow pressures of their open-ended peers. These are operating like private equity funds, providing capital to specialist areas, and the investment trust structure, with its discount/premium model, potentially allows entry to these niche sectors at attractive valuations.

Some investors may have concerns around volatility with these vehicles and it should be noted that, as listed equities, they can sometimes have a temporarily higher correlation to broader markets, particularly in extreme conditions. In most cases, however, there is limited impairment to the assets or underlying NAVs during such periods and the income and dividend profile, and fundamentals, either remain stable or improve; as panic subsides, these assets tend to re-rate.

Last year serves as an example here; while the NAVs of our holdings mainly held up, the more volatile price action amid pandemic volatility was as expected given the nature of the vehicles we use to access these parts of the market. A longer holding period allows investors to ignore any short-term sentiment-driven noise and benefit from the many long-term advantages of Real Assets.

Looking at these alternative options in more detail, staying with property, many open-ended funds continue to have high exposure to the mainstream commercial end of this market such as offices and retail. These face structural challenges in the post-Covid environment, although this is not to say there is no commercial value left. In contrast, we believe real estate investment trusts (REITs) to be more transparent, giving greater access to and understanding of the underlying assets. This universe also allows access to more specialist areas and managers focusing on subsectors with structural growth such as healthcare, logistics and digital infrastructure. 

Moving to infrastructure, a unique feature is the fact that a significant amount of revenues benefit from stable, predictable demand, making these assets more economically resilient and less affected by the business cycle. These defensive qualities are supported by long-term inflation-linked cashflow streams, which are typically government backed. Given these sectors often provide critical services, used for social or environmental purposes, they tend to enjoy accommodative government policies (through tariffs and grants) and regulation. Such accommodative policies should also continue to evolve given the government’s ambitious net zero targets and levelling up agenda.

We are currently in the midst of a once in a generation investment in infrastructure in the UK. The government’s commitment to be net zero by 2050, as demonstrated by its 10-point plan for a green industrial revolution, has the potential to deliver an estimated £42 billion of private investment by 2030 across energy, buildings, transport, innovation and the natural environment. We can get involved in this through the closed-ended world while achieving our primary objectives within multi-asset investing.

Renewables, a subsector of infrastructure, also benefit from long-term contractual cashflows. But these are a combination of government subsidies and revenues from selling electricity to power companies and the demand from the latter introduces an element of economic risk. To compensate for this, dividend yields available are often slightly higher.

All three areas of Real Assets offer the benefits of traditional ‘property’ without the liquidity mismatch and we see a strong case to hold them over the long term to bring diversification, income and potential inflation protection.

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Key Risks

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Some of the Funds and Model Portfolios managed by the Multi-Asset Team have exposure to foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The majority of the Funds and Model Portfolios invest in Fixed Income securities indirectly through collective investment schemes. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. Some Funds may have exposure to property via collective investment schemes. Property funds may be more difficult to value objectively so may be incorrectly priced, and may at times be harder to sell. This could lead to reduced liquidity in the Fund. Some Funds and Model Portfolios also invest in non-mainstream (alternative) assets indirectly through collective investment schemes. During periods of stressed market conditions non-mainstream (alternative) assets may be difficult to sell at a fair price, which may cause prices to fluctuate more sharply.

Disclaimer

This information should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and if you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

Tuesday, November 23, 2021, 10:26 AM