In this first of our ‘sector focus’ features Annie Borg, Research Analyst on the Casterbridge Research Team, answers some topical questions surrounding the commercial property market; why hold it in a portfolio? What does it offer investors? What are the liquidity risks?
Commercial property – Where do we go from here?
Well, despite finding funds that meet our due diligence process and investment themes, the correlation table below shows that throughout Q1 the correlation of Global Real Estate Investment Trust (REIT) funds was not only highly correlated to our portfolios but also to the MorningStar UK Large Cap Index (a FTSE100 proxy) at a range of 0.90 to 0.97 – as a reminder 1.00 is perfectly positively correlated! This was due to the underlying exposure of REITs having equity-like risk and due to the increased allocation to passives within the industry. The large sale of these assets at the start of the COVID-19 sell-off had resulted in stock prices plummeting for equities across the board despite their financial resilience or underlying asset, in this case commercial property.
Lingering uncertainty within global markets due to the COVID-19 pandemic has meant that many portfolio managers are continuing to allocate to alternative asset classes, such as commercial property, with the aim of providing a level of portfolio protection. However, the above correlation table shows that throughout the recent market volatility assets that have traditionally demonstrated low or negative correlation with one and other and thereby provided a degree of protection – have not been doing so!
Throughout the first quarter of 2020, we have been underweight commercial property, with our Hardy Managed Portfolios selling the remainder of their allocation to physical commercial property in December 2019 due to the ongoing concerns surrounding a lack of liquidity and possibility of funds gating. Despite commercial property being viewed as a safe haven asset, our investment team believed that daily dealing was a thing of the past when it comes to immovable assets, accepting that there is likely to be a fundamental regulation change requiring these funds switch from daily dealing to weekly or monthly.
For clients in our Bespoke Portfolio Service we halved their exposure to commercial property coming into the start of the year. We continued to hold our preferred commercial property fund on the back of a very strong track record and less than a quarter of its assets in UK direct commercial property, it had a low risk of suspension. However, what was around the corner tested even the strongest funds in the sector. With valuers unable to visit sites during the lockdown and with ‘material certainty’ they were unable to accurately price the fund’s buildings and the fund was suspended. This however is not all bad. A suspended commercial property fund is better than one that stays open during stress periods and provides liquidity to investors at any price – this practice often creates a rush for the door and a panicked disposal of assets. With the fund suspended the managers can focus on the orderly sale of the underlying commercial properties to meet redemptions, if required, and prevent a panicked retreat.
Before this suspension, we had already conducted suitability of a Global REIT fund for inclusion within portfolios as an alternative to gain our commercial property exposure within our Hardy models, and to replace the underweight position to direct property within Bespoke portfolios.
Across our portfolios we took the active decision to hold cash where we are not holding commercial property, which has proved to be a positive asset allocation decision throughout the first quarter with the MSCI UK IIMI Liquid Real Estate returning -18.39% as demonstrated in the chart below.
Some final thoughts…
The lack of property within the Hardy models is expected to continue until we have market clarity. Should our house view change, a fund has already been selected which expressly meets our investment themes of being exposed to Healthcare and Technology sectors. In addition, it has a low exposure to sectors of concern such as retail and office space. Should we wish to allocate to the property sector, but with accepted equity like risk. Similarly, Bespoke has added Welltower US REIT to portfolios as it chimes with our healthcare and US equity market themes.
Annie Borg, Research Analyst Casterbridge Wealth.
This update is for information only and does not constitute advice or a recommendation and you should not make any investment decisions on the basis of it. The views and opinions within this document are those of Casterbridge Wealth at time of writing and may change without notice. They should not be viewed as indicating any guarantee of return from an investment managed by Casterbridge Wealth nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.