Finding Room for global property in your investment portfolio
Global property was one of the best performing asset classes in 2019, achieving a total return of 24% in USD. In the long term also, Global Property is a dependable performer, delivering over 10% per annum (USD) total returns over both 10 and 20 years ending 2019. In addition to providing attractive long term returns, Global Property also has unique characteristics as an asset class, providing investors with diversification benefits, justifying room for itself in a balanced portfolio.
1. WHAT MAKES GLOBAL PROPERTY AN ATTRACTIVE ASSET CLASS?
Global Property (more widely known as ‘real estate’ outside South Africa) is the largest asset class in the world. Savills estimates that, residential and commercial property assets have a combined value of approximately USD200 trillion, more than all other investment asset classes in aggregate. So, if it’s the most abundant asset class, what makes it so special?
- Property in the world’s most desirable cities is a store of value due to finite supply of land
- It is a tangible asset and the only asset class that provides space for people to live, work and play
- Property is an enabler of other economic activities and therefore adds to economic growth through jobs and productivity gains (which is why Governments in 30 countries have implemented REIT regimes)
- In some cases, iconic, reflective of humanity’s achievements
The world’s largest asset class and still growing: PwC estimates that the stock of institutional grade commercial property in developed countries is due to reach USD25 trillion in 2020 (with a further USD20 trillion in Emerging Markets). Most of this stock is owned by financial institutions in various private closed and open – ended fund structures. Approximately 15% of this stock is owned by listed property companies, many of which are REITs (Real Estate Investment Trusts) that form part of our Listed Property investment universe at STANLIB Asset Management.
1.1 Listed Property is a unique industry
The listed property sector has grown in size and importance globally to the extent that in 2016, S&P Dow Jones indices and MSCI created a new Global Industry Classification Standard (GICS) in recognition of the importance of this asset class. The GICS Real Estate sector is the only new sector created by the index providers since 1999 and now accounts for approximately 4% of the index capitalisation, making it the 8th largest sector (out of 11) (Previously, listed real estate companies were classified within the GICS Financials Sector).
Similarly, FTSE Russell’s Industry Classification Benchmark (ICB) undertook structural enhancements including the creation of a Real Estate sector, effective July 2019. “FTSE Russell noted that the lower correlation of listed real estate to other stocks in the medium to long run may help diversify investment portfolios”. This reflects FTSE Russell’s belief that the real estate segment has reached critical mass in global stock markets. Real estate stocks (including REITs) comprise on average just over 5% of total equity market capitalisation in the world’s top 10 developed markets (as shown in the table below), representing over USD 2.5 trillion of listed investible market capitalisation.
1.2 Listed Property is a significant component of markets
1.3 Listed Property is a driver of economic growth and a tax-efficient investment option
In recognition for their contributions to productivity and therefore economic growth, REITs enjoy tax advantages which are not available to other institutional commercial property investors. The principal advantage being that net income is exempt from corporate income and capital gains taxes to the extent that this income is distributed as a dividend and provided that they abide by REIT regulations (each country has its own REIT regime). This provides investors with the opportunity to benefit from owning several types of institutional grade property in the world’s leading cities through stock exchange listed shares in a tax efficient manner.
1.4 Listed Property provides opportunities over and above non-listed property
As listed entities, REITS offer a volatility premium to property investors. Over the long-term REITS’ returns are highly correlated to their underlying asset values (see below chart) but over the short-term investors can capitalise on market mis-pricing. The volatility caused by being listed adds risk in the short term but also creates opportunities for the savvy REIT investor.
2. GLOBAL PROPERTY PROVIDES DIVERSIFICATION BENEFITS WHEN INCLUDED IN A BALANCED FUND
Global Property has delivered one of the highest annualised total returns over the 10 and 20 years ending 31 December 2019 across asset classes, exceeding returns from Global Equity by approximately 2% per annum (in ZAR)
Source: Bloomberg, Stanlib estimates
Global Equity: MSCI All World Index, SA Property: All Property Index ; SA Equity: JSE All Share index ; Global Bonds: Barclays Global-Aggregate Total Return Index, ,SA Bonds: ALBI total return index SA Cash: SAFE South Africa Short Term Fixed Interest Rate.
2.1 Diversification in an SA Balanced Fund
As shown in the chart below, Global Property has had similar risk and return profile to Global Equity over the last 10 years, although per unit of risk, Global Property has performed slightly better.
Second, STANLIB in house analysis indicates that maximising the Sharpe ratio in the offshore allocation of an SA Balanced Fund (with a 30% offshore limit) is best achieved with a 50:50 split between Global Property and Global Equity (suggesting a 15% total fund allocation). The Sharpe ratio is maximised at 1.32 (on a 50:50 allocation) from 1.22 (100% Global Equity), reflecting the relatively low correlation between the two asset classes.
Source: STANLIB Asset Management
2.2 Diversification in a GLOBAL Balanced Fund
Research by Oxford Economics on behalf of EPRA also supports our analysis above, for a multi asset portfolio outside of the RSA:
“Focussing on the potential contribution of listed real estate to the performance of a multi-asset portfolio, we find that a substantial allocation to this asset class does generally improve the portfolio’s risk-return characteristics. The optimal allocation tends to increase with both the holding period of the portfolio and its level of risk/return, reflecting our finding that listed real estate has generated higher returns (with correspondingly elevated volatility) than competing asset classes”. Listed Real Estate in a Multi-Asset Portfolio (EPRA and Oxford Economics)
2.3 Listed Property low correlations with other asset classes
These diversification benefits arise out of the relative low correlations with other asset classes. We show in the table below the correlation between Global Property (using FTSE NAREIT All Equity REITs as a proxy) and other asset classes over a 10 year (upper half) and 20 year (lower half) time horizon.
- Low correlation to broad equity markets over the last 20 years: Listed real estate company returns and broader equity stock market returns show a correlation of 0.43-0.62 as shown in the table above;
- Geographic diversification. Investors can select specific exposures to specific well defined geographies / city neighbourhoods. An exposure to institutional grade offices in London’s City and London’s West End provide significantly different risk-return profiles.
- Subsector diversification. Listed real estate companies provide exposure to unique real estate subsectors, varying from the traditional subsectors (such as Retail, Office and Industrial) to new and relevant niche subsectors (such as Cellular phone towers, data centres, Life science laboratories, manufactured homes, student housing) among others.
This sub-sector diversification is important as it allows the savvy investor to take advantage of unique opportunities that play into global trends, such as:
- the growth of online retail driving the demand for warehouse space at the expense of shopping centre space
- Ageing populations that are financially independent driving demand for senior housing facilities
- Explosion in biotechnology and life science research and services with a view to further enhance human health and longevity driving demand for medical office space
- Greater rates of mobility and urbanisation that are driving densification thereby drastically increasing per square metre accommodation costs (of all types), driving demand for self storage
- Increased preference for rental housing at the expense of home ownership (all types of residential) driving demand for institutionally owned and operated accommodation
- Increased need for cloud services and higher data transmission speeds driving demand for data centres and increasingly powerful cellular telephone towers
- Property being increasingly seen as a service offering as opposed to a long-term financing solution
At Stanlib Asset Management, we are convinced that there is room in every balanced portfolio for an allocation to Global Property and our analysis shows that a 15% allocation in an SA Balanced Fund optimises the Sharpe ratio.
Our key takeaways are:
- Global Property is a unique asset class with a distinct risk and reward profile
- Global Property is a high return asset class (10% per annum in USD over both a 10 year and 20 year timeframe to end December 2019)
- Adding Global Property to a Balanced Fund enhances the Sharpe Ratio and
- Global Property shares are underpinned by real assets that have a residual value, regardless of economic conditions.
Did you know?
In 2019, the 3 best performing developed market listed property shares in Global Property were:
A living room’s sole purpose is to provide a shared space for its residents. Shared experience is what makes life richer and more memorable. Just as you wouldn’t build a house without a living room, designing a Balanced Fund without a Global Property allocation is to miss out on shared experience!