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Reit rout a warning sign for property funds, says Hawksmoor

Positive returns for open-ended property funds last year despite heavy falls for Reits shows 'optimistic' pricing, says Ben Conway.

Reit rout a warning sign for property funds, says Hawksmoor

The heavy share price falls suffered by real estate investment trusts (Reits) last year serve as a warning sign for investors in open-ended property funds, according to Hawksmoor fund manager Ben Conway.

Shares in a number of Reits were hit hard last year amid fears over Brexit and the challenges facing the UK high street.

Intu Properties (INTUP) was the worst hit, losing more than half its value in a year that featured the collapse of a takeover deal by a consortium of investors. 

Shares in shopping centre owner Capital & Regional (CAL) suffered an equally torrid year, down 53% over the 12 months to the end of September.

The FTSE 100-listed British Land (BLND) and Land Securities (LAND) were down 23% and 20%, while Hammerson (HMSO), which lost its blue-chip status last year after its ill-fated attempt to buy Intu, dropped 40%.

But it was a different story for open-ended property funds. Funds in the Investment Association's UK Direct Property sector emerged as the best performers of the year, delivering an average 3.9% return.

Property fund performance unwinding

Conway, an investor in Reits through his Hawksmoor Vanbrugh and Distribution funds, which in invest in other funds and investment trusts, said the performance of open-ended property funds last year was 'potentially misleading'.

'The much worse performance of Reits, which are obviously listed vehicles that price on a minute-by-minute basis, suggests that perhaps the performance of open-ended property funds is slightly optimistic,' he said.

‘We don’t invest in open-ended property for a number of reasons and I think the strong performance of sector 2018 could very easily unwind and in fact is already doing so this year.'

Conway pointed to the 5.7% hit suffered by investors in the £1 billion Kames Property Income funds after the managers switched pricing to deal with withdrawals amid Brexit fears.

Columbia Threadneedle made the same switch on its £2.7 billion UK Property Authorised Investment funds, dragging them down by 6.1%.

‘It’s always been a problem that’s been waiting to happen,’ Conway commented. ‘Here you’ve seen wonderful gains of the last year’s return wiped off in one fell swoop.’

Both Kames and Columbia Threadneedle moved from ‘offer’ to ‘bid’ pricing to account for the possible costs involved in selling properties as investors withdraw their money.

That's because, as open-ended funds, they are able to create more shares, and buy more assets, when investors are putting more money into the fund, but need to cancel shares, and sell assets, when investors are taking money out.

By making the switch, the pricing of the fund is based on its assets less the estimated costs associated with the sales. 

This is lower than 'offer' pricing employed when the fund is enjoying inflows, which reflects the assets of the fund plus the estimated costs associated with buying properties.

Closed-ended funds like Reits, by contrast, are not forced to sell assets at times of market stress. Investors who want to exit can simply sell their shares on the market for whatever price they can get.

‘This is the problem with funds that offer daily dealing – the underlying assets should match that liquidity,’ Conway argued. 

Focus on income, not assets

Conway also took issue with the role of net asset value in driving returns for open-ended property funds, as the valuations of the underlying properties were unlikely to be met by buyers should funds be forced to sell multiple properties to fund withdrawals.

‘This is the problem with lots of more illiquid assets, including private equity...it’s valued on a quarterly basis by a third party and is based on subjectivity,’ said Conway.

This was particularly an issue in the ‘decimated’ retail sector, he said, where tenants would vacate a property with no natural replacements, with landlords reliant on a surveyor to tell them what they think the property is worth.

His focus when investing in property through Reits is instead on the income provided from dividends.

‘This is why we focus on income – is it fully covered? How good are the tenants?’ he said. ‘NAV is completely secondary.’

Conway's closed-ended property fund holdings include Civitas Social Housing (CSH), PRS Reit (PRSR) and Phoenix Spree Deutschland (PSDL).

He recently sold long-lease trust LXI Reit (LXI) on strong performance, with the shares up 22% over the last 12 months and trading on a 7% premium to NAV.

Shipping trust tops shopping list

Recent buys include C-share offerings from Tufton Oceanic Assets (SHIP) and BioPharma Credit (BCPR).

Conway (pictured) likened ship-leasing trust Tufton to a Reit, as a form of ‘floating property’, in the way it derived income from occupants.

Tufton, which offers a 4.8% yield, floated in December 2017 and raised $78.4 million (£61 million) in October.

‘Demand has started to outstrip supply – it’s worked through its oversupply issues,’ said Conway. ‘Global trade has not gone away…The shipping cycle is different to the global economic cycle and there is every chance of its income growing.’

Income was also the key attraction that drew the manager to BioPharma Credit, the only trust focused on healthcare lending, which came to market in March 2017 and has a yield of 6.3%.

Conway was surprised how big the trust had become in that time, with a market capitalisation of £1.1 billion, but said it had tapped into a key opportunity given the disintermediation of banks following the financial crisis.

‘Banks have only been doing plain vanilla lending since the financial crisis,’ he said.

Despite the risk inherent in investing in life sciences, he said BioPharma had identified quality loan deals rather than ‘blindly throwing’ money at companies.

Throughout choppy markets which plagued funds in the fourth quarter of 2018, Lockyer said it was exposure to gold, managed future and absolute return funds that cushioned performance in the Vanbrugh and Distribution funds.  

In September, Hawksmoor also launched the Global Opportunities fund with a focus on emerging markets and Asia.

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