Diversified Alternatives – introducing property

A row of five red, wooden hotels from the board game Monopoly, on a table.
For financial professionals only

In the last of the series on Diversified Alternatives, Investment Director Harry Garrett explains why we’re still fans of property, and why we’ve brought it into our new asset class rather than it still standing alone.

First, here's a quick reminder of the thinking behind Diversified Alternatives:

The four underlying asset classes within Diversified Alternatives are blended in equal portions to represent our strategic positioning. By broadening the asset class across different sub asset classes we reduce the known risks of investing in direct property while maintaining a different return profile to that of traditional equities and bonds.

What do we mean by property?

Many people invest directly in property through owning and letting residential property, but as an asset class it is usually accessed through collective funds.

Property funds can include directly-held UK commercial properties such as offices, warehouses, supermarkets etc and/or indirectly through listed property companies. We prefer funds directly invested in bricks and mortar funds.

What are the portfolio benefits?

Property has historically been widely favoured by investors thanks to two key strengths: diversification and regular income. Over the past few years the sector has experienced consistent outflows, but PIM have continued to favour the asset class for a number of reasons.

A relatively low correlation with equities and fixed income makes property an important diversifier, and history shows that it has often performed strongly when other asset classes are lagging. According to FE Analytics, the Property Direct UK sector is up 11.2% over the past year, a period in which most other asset classes have delivered negative returns.

Property investments also provide a steady, regular income from the rent produced by underlying holdings, while offering good potential for capital growth over the long term. The reliable yield it generates makes property an important source of income for investors in the low-growth, low interest rate environment of the post-financial crisis era.

What are the risks?

Like any investment, property comes with its risks. One risk that’s come under the spotlight over recent years is the issue of liquidity.

Open-ended property funds allow daily dealing, but the underlying assets they invest in (typically commercial property) take much longer to sell, particularly in times of crisis.

This creates a ‘liquidity’ mismatch, meaning funds need to keep a reserve of cash so they can meet investor redemptions.

However, some open-ended property funds have been forced to close their doors to redemptions to protect investors from the impact of large-scale withdrawals. Many open-ended property funds now hold significantly increased cash levels in order to prevent this, and that dilutes returns.

The Financial Conduct Authority (FCA) has consulted on introducing statutory notice periods of 90 or 180 days for withdrawals from property funds, in an attempt to reduce the liquidity mismatch (1). The enhanced transparency provided should allow funds to hold less cash.

However, the FCA has yet to confirm its preferred approach – and this ongoing uncertainty has contributed to further divestments and even a number of property fund closures over the past year.

The power of diversification

These liquidity and regulatory risks are part of our rationale for expanding our Diversified Alternatives asset class.

However, the proven diversification and income benefits mean property continues to play a vital role in our strategy. Combining property with other assets - infrastructure, short-dated bonds and absolute return funds - enhances the diversification within the Diversified Alternatives asset class while providing a similar risk and return profile. As a result, it should ensure that investors enjoy even better consistency of risk-adjusted returns over time.

Past performance is no indicator of future returns, the value of investments and the income from them may go down as well as up and investors could get back less than they put in.

(1) https://www.fca.org.uk/news/statements/fca-statement-work-liquidity-mismatch-authorised-open-ended-property-funds 

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.  

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