When you invest in listed property, your objective should be a key factor in your decision on whether to invest in an actively managed fund or an index fund. If your objective is to earn an income, you should realise that the sector’s benchmark index may not include shares that have the best income-producing capabilities.
At the same time, the lack of liquidity in the South African listed property sector makes it difficult for large active managers to invest in small shares that they believe will out-perform the benchmark index.
The active-versus-passive issue was debated during a panel discussion at the IPD South Africa Property Investment Conference in Cape Town last week.
In a presentation before the discussion, Len Jordaan, the head of exchange traded funds (ETFs) at Stanlib, put the case for choosing an index fund when you invest in property. Index funds are much cheaper than actively managed funds, and the most efficient way to increase returns in a low-return environment is by reducing costs, he said.
Putting the case for using an active fund manager in the property sector, Angelique de Rauville, the chief executive of Texton Property Fund and the former head of Investec’s global property investment division, said there is currently a huge disparity between the income yields and prices of property shares, and therefore active management was required to find the best opportunities.
De Rauville told Personal Finance that the average yield (income calculated as a percentage of share price) for the sector is about 7.3 percent, but some shares are trading at yields of about five percent (for example, New Europe Property Investments is at 4.8 percent, Hyprop at 5.3 percent, Rockcastle at 4.5 percent and Resilient at 4.9 percent), whereas others are trading above nine percent (for example, Emira is at 9.4 percent, Octodec at 9.5 percent, Texton at 10.8 percent and Rebosis at 10.1 percent).
Some shares, such as Hyprop, Resilient and Rockcastle, are trading at premiums of over 40 percent of their net asset values (NAVs), whereas others, such as Emira, Vukile and Texton, are trading near or below (Rebosis, Synergy-B) their NAVs, she says.
De Rauville says it is not easy for an active manager to achieve alpha (out-perform the market) when all the stocks in the sector are trading at yields of between seven and eight percent, but there is “a very clear case” for active management when some shares are “clearly overrated relative to others”.
Ian Anderson, the chief investment officer of Grindrod Asset Management, told Personal Finance that while the active-versus-passive debate will go on forever, what investors need to ascertain is how these different approaches will best serve their investment objectives.
Grindrod Asset Managment manages the Nedgroup Investments Property Fund (an actively managed fund), while CoreShares, a division of the Grindrod Financial Services Group, offers two index-tracking property funds.
Traditionally, people have invested in listed property to earn a sustainable and inflation-beating income, not primarily to diversify their portfolios, Anderson says.
However, changes in the listed property market over the past four years have undermined the ability of the sector as a whole to generate income. These changes include the advent of offshore companies, which have low income yields, and property developers, which do not pay dividends.
For example, he says the inclusion of low-yielding offshore real estate investment trusts (reits) and development companies (such as Attacq) in the FTSE/JSE SA Listed Property Index (SAPY) resulted in distributions (income paid to investors) in the Coreshares PropTrax SAPY Fund falling by 11 percent in 2011 and 2012, whereas distributions in the Nedgroup Investments Property Fund increased by 11.9 percent over the same two-year period, because the fund avoided developers.
Grindrod Asset Mananagement’s investment objective is to generate a sustainable, inflation-beating income, and therefore it does not use index-trackers to gain exposure to listed property in its multi-asset portfolios, Anderson says. However, if your reason for investing in listed property is to diversify your portfolio, or to grow your capital, you may be better off in a low-cost index-tracking fund than in a higher-cost actively managed fund, he says.
Grindrod is a small, boutique asset manager, and Anderson says that managers with far more assets under management may not have as much freedom to differentiate their holdings from those in the index, because smaller property companies are not as liquid (there is insufficient scrip for managers with large amounts to invest).
Anderson says the shares of large property companies that have been included in local and offshore equity indices have taken on equity-like characteristics, generating returns largely from capital appreciation and showing short-term volatility. Money flows into these funds simply because they are in the index, boosting their prices – but investors need to ask whether the premiums at which these companies’ shares trade are realistic.
Keillen Ndlovu, the head of listed property at Stanlib, told Personal Finance he accepts Anderson’s point about how investment objectives can affect the decision to opt for active or passive investing. However, he says, no matter what your investment objective, a problem with passive investing is that, even if a share is over-valued, you have to invest in it if it has been included in the index.
The listed property market is, on average, over-valued by 35 percent, but an active manager can find shares that are trading at fair value or at significant discounts to their NAVs, Ndlovu says.
Stanlib has two actively managed funds in the listed property sector, the Property Income Fund and the Multi-manager Property Fund, and a passively managed ETF.
Ndlovu says that Stanlib’s actively managed property funds have an income focus. He says active managers struggled to out-perform the index in the past, but this has changed recently, and it is possible for them to produce performance that compensates for their fees.
Investors should remember that the SAPY consists only of the 20 biggest listed counters, by market capitalisation, and active managers can find many more opportunities outside the index, he says.
Ndlovu says a lack of liquidity in small shares is not the problem that it used to be for large asset managers.
Duncan Schwulst, the manager of Prudential’s Enhanced SA Property Tracker Fund, told Personal Finance that his fund takes a middle-of-the-road approach that seeks to address the problems of investing actively or passively in listed property. The Prudential fund is actively managed using quantitative analysis (stocks are selected using computer models and human judgment) that seeks to take advantage of mispricing.
Using one-year forward distribution yields (estimation of a year’s dividend expressed as a percentage of current share price) as a basis for valuation, the fund under-weights (relative to the SAPY) shares that Prudential identifies as expensive with low yields and over-weights cheap shares with high yields, Schwulst says.
The South African listed property market is relatively homogenous (all companies generate returns from similar types of assets), Schwulst says. The fundamental drivers of earnings (for example, escalating rental income) are well known and stable. This makes it very difficult for an active manager to identify shares that are priced below their intrinsic value, because investors have all the information about the shares.
Schwulst says that mergers and acquisitions are far more prevalent in the listed property market than in other sectors of the JSE, and levels of stock issuance are high, with the result that passive managers constantly have to adjust their holdings to reflect the index. Market impact costs and fund costs can result in a passive fund under-performing the benchmark.
Jordaan says there is a space for both active and passive investing. Low costs, liquidity, certainty of returns and simplicity are the main benefits for retail investors of index investing. But, he says, active investing provides investors with far more flexibility, because active managers can avoid over-priced shares and sell down or sell off shares in a market sub-sector that will under-perform.
With any asset class, not only listed property, the lack of liquidity of smaller shares is a challenge for large asset managers that are looking to out-perform by taking positions that differ significantly from the index, Jordaan says.
In South Africa, investors are not deriving the full benefit of active management, because fund managers tend to follow benchmarks very closely, Jordaan says. Investors and asset management companies should give active managers the freedom to take larger positions in fewer shares.
INDEX CONSTRUCTION AFFECTS RETURNS
If you choose to invest in listed property using passive investments, you need to understand the criteria used to construct an index, because the constituents of the index affect how an index-tracking fund performs.
The traditional benchmark for domestic listed property is the FTSE/JSE SA Listed Property Index (SAPY). This index captures the performance of the top 20 property companies, by market capitalisation (value of publicly issued shares), with a primary listing on the JSE. The SAPY does not cap the weighting of any particular share, and it excludes companies with a primary listing offshore.
A “property company” means a company listed in the “real estate investment and services” or the “real estate investment trusts” sector of the JSE.
One of the criticisms – and risks – of tracking the SAPY is that, although it gives investors exposure to 20 shares, five shares account for about 65 percent of the market capitalisation of the index, Len Jordaan, the head of exchange traded funds (ETFs) at Stanlib, says.
Commentators have pointed out that companies can choose the JSE as their primary listing simply to be included in the SAPY. New Europe Property Investments, which is one of the “big five” shares in the index, is based in Romania and does not own property in South Africa.
Of the five index-tracking funds in the South African real estate general sector, four funds track the SAPY. The CoreShares PropTrax Ten ETF tracks a bespoke index, the FTSE/JSE SA Listed Property Top 10 Equal Index. The index consists of the top 10 companies, by market capitalisation, in the SAPY but holds them in equal weightings of 10 percent.
Gareth Stobie, the managing director of CoreShares, says weighting the constituents of the index equally attempts to correct the concentration risk in the SAPY by down-weighting large shares, such as Growthpoint and Redefine, while up-weighting smaller shares.
On a total-return basis, the PropTrax Ten out-performed the CoreShares PropTrax SAPY Fund over one and three years to the end of June 30, according to ProfileData (the PropTrax Ten does not yet have a five-year history).
Stobie says the yields on the larger shares have been lower, so down-weighting them in the PropTrax Ten has served to push up yields in the fund.