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Illiquidity Bites

The ongoing upheaval in the UK claimed another high-profile casualty last month when one of the country's largest property portfolios announced it was suspending share trading, blaming "continued Brexit-related political uncertainty and ongoing structural shifts in the UK retail sector".[1] The fund's freezing has intensified the spotlight on the suitability of traditional open-ended property funds to offer clients daily liquidity while investing their money into highly illiquid property assets. This structural flaw last surfaced in 2016 when seven large UK property funds were forced to suspend investor redemptions amid market uncertainty surrounding the Brexit referendum.

The dangers of liquidity mismatches in financial markets are not a new phenomenon. They sparked the panic in the banking sector in 2008 that caused the global financial crisis and their risks were painfully exposed to many mainstream UK investors last year during the Woodford debacle. The fund manager was forced to close when clients lost confidence in his stock-picking ability and he was unable to sell unquoted and illiquid stocks fast enough to meet their redemptions.

Structural benefits

With further clouds on the economic horizon, these issues serve to underline the structural benefit of SKAGEN m2, as Portfolio Manager, Michael Gobitschek, explains: "By design our fund only invests in listed real estate companies, funds or trusts (REITs). These avoid the liquidity pressure of direct property investment as their shares can be traded easily on conventional stock markets without the need to sell underlying property assets to provide liquidity."

The strain ultimately became too much for M&G whose property portfolio had around 40%[2] of client funds tied-up in hard-to-sell retail assets. Last year saw established high street names such as Mothercare, Debenhams and Thomas Cook disappear into administration and the outlook for many other retailers remains bleak in the face of rising costs, falling consumer confidence and the shift to online shopping. Similarly, while December's general election result has provided some short-term clarity over Brexit, the UK economy still faces considerable longer-term uncertainty which will inevitably impact real estate markets.

As well as greater liquidity, listed property vehicles also provide investors with greater transparency into the underlying assets and accuracy as to their value. Many provide daily NAV estimates and detailed quarterly reports in addition to twice-yearly financial statements which are approved by independent directors and auditors. Direct real estate funds, in contrast, often hold their illiquid assets at historic valuations which can overstate their realizable value, particularly when liquidity dries up. British Land, one of the UK's largest real estate companies, recently signaled further trouble ahead for retail property after writing down its own portfolio by over 10% in the six months to October, following an 11% mark-down in the year to March.  

Another advantage is better diversification. The listed real estate market is large and growing with REITs, in particular, expanding rapidly by geography, sector and tenants (see below). SKAGEN m² has a global mandate and is currently invested across 15 countries (with none representing more than 23% of the fund) and 8 different sub-sectors (with none making up more than 25% of assets)[3]. Listed investments also offer easier access to non-traditional assets, as Gobitschek outlines: "We have exposure to the structural growth of e-commerce through companies such as Catena, a logistics facilities supplier, and Keihanshin Building Co. which provides data centres in Japan. Investing directly into these types of attractive assets would be much more difficult, expensive and risky than doing so via listed securities on regulated exchanges."

Impressive returns

Perhaps unsurprisingly given its many attractions, listed real estate has performed strongly in absolute and relative terms over different horizons. REITs were the second-best performing asset class in 2019, delivering 30.4% in EUR[4] and have outperformed equities and bonds over a forty five-year period, with an impressive compound annual return of 11.8%[5]. While the sector underperformed during the financial crisis, this was largely due to high levels of debt and leverage is now much more conservative at around 30% of asset value, compared with nearly 50% in 2007[6]. Indeed, REITs have been the best performing asset class since 2008 with an annualized return of 10.6%[4].

From an asset allocation perspective, listed real estate is also attractive as its low correlation with equities and bonds, particularly over longer holding periods, makes it a valuable portfolio diversifier (see figure 1). Research[7] covering 1972–2015 demonstrates how adding a 10% allocation to REITs in a stock and bond portfolio increased annual returns from 10.0% to 10.3% with no additional risk and doing the same to a fixed income portfolio boosted returns from 8.6% to 9.1% while reducing risk. The compounding effect of these gains over such a long holding period is clearly significant.

The chart above also highlights that returns from listed real estate are strongly correlated to those from direct investment, despite seeming to represent lower risk, particularly in an uncertain economic climate. "With many direct property funds currently looking to increase their cash levels to fund redemptions from nervous investors, their future returns may face significant headwinds, particularly if assets are sold at distressed prices and the proceeds invested at record low interest rates," Gobitschek adds. "Listed vehicles, on a relative basis, could flourish – especially those with the dry powder available to make acquisitions in a buyer's market." 

Repeatable success

For investors looking to invest in real estate to safeguard against an equity market correction, avoid the miserly yields on offer in the bond market or simply improve their portfolio diversification, SKAGEN m2 looks well-placed to continue its success. Our award-winning[8] team delivered EUR returns of 29.4% in 2019, 13.5% ahead of its benchmark, which it has now beaten in each of the last four calendar years.

Looking ahead, against an uncertain global economic backdrop and the likelihood of heightened volatility, the investment team has valuable experience over several economic cycles and a proven investment process. With sustainability also fully integrated and a key investment theme, SKAGEN m² is able to navigate ESG risks while taking advantage of the growing need for greener and self-sustaining cities. Finally, the fund's global mandate, combined with our nimble approach, means we can capture the best opportunities and avoid the biggest risks in an exciting and expanding investment universe.


[1] Source: M&G press release
[2] Source: M&G Property Portfolio November 2019 Factsheet
[3] Portfolio data as at 31 December 2019
[4] Source: J.P. Morgan Asset Management, as at 31 December 2019
[5] Source: Morningstar, 1972-2017
[6] Source: Bloomberg
[7] Source: Morningstar, 1972-2015
[8] AA rated by Citywire and ranked #5 of 148 portfolio managers over three years in the Property-Global Equity category; Awarded four stars by Morningstar; European winner of 2019 Lipper Awards in Global equity real estate category three years



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