June 16, 2004

By Jaco Maritz

Despite recent hype about the superior performance of property, institutional asset managers continue to hold low levels of it in retirement fund portfolios.

It is worthwhile pointing out the advantages of investing in property:

n It serves as a risk-reducing agent in a portfolio that contains multiple asset classes.

This stems from two aspects. Property has a weak correlation with other asset classes, notably equities. This means property does not tend to track movements in the equity markets, thus providing a measure of stability to portfolios with multiple asset classes.

In addition property, especially physical property, is significantly less volatile than other asset classes, providing some protection against a fall in fund value when markets collapse.

Property often yields returns above inflation and delivers strong cash flows. Data released by Investment Property Databank suggest that directly held property has yielded a remarkably stable income return since 1995, averaging 10 percent a year and beating inflation, which averaged 6.3 percent.

This performance was sustained over a period when inflation fluctuated, reaching a high of about 13 percent in the second half of 2002 before reaching current record lows.

Physically held property appears to be a solid hedge against inflation, a result that absolute return funds try to achieve with combinations of bonds and appropriate stock picks.

n It makes sense to reflect the overall investment universe in an investment portfolio. By down-weighting or ignoring property, asset managers are taking an unintentional bet against property.

To establish whether fund managers would prefer listed or directly held property, one should note that listed property offers substantial advantages over directly held property.

One advantage is that listed property is traded on the JSE Securities Exchange as units of a property portfolio, enabling an investor to spread the investment over a number of counters.

A second advantage is that fund managers do not have to hire specialist property managers to oversee a portfolio.

The question remains: why do fund managers shy away from property, be it listed or directly held? The major inhibiting factor is the relatively low liquidity and small size of the listed property sector. The JSE real estate sector represents only about 2.9 percent of market capitalisation.

Liberty International, by far the biggest real estate company, represents exclusively UK-based property assets, and this leaves an assortment of mid- and small-cap stocks to choose from for exposure to domestic property.

These stocks are notoriously difficult to trade, especially for a large investment house that needs significant holdings to achieve noteworthy exposure to listed property.

The low liquidity in the listed property sector can be alleviated if institutions list significant tracts of directly held property.

Listed property earnings yields are currently about 2 percent above the average physical earnings rates, creating an environment in which it is attractive for institutions to list their property portfolios.

Consolidation of the smaller listed property funds would be beneficial, creating fewer, larger and more liquid counters.

We should, however, note that relatively low liquidity should not inhibit the private investor.

Compared with directly held property in international markets, South Africa has a very high retail component, with no residential component.

Institutional residential property probably represents a huge opportunity in South Africa, but perceptions of restrictive legislation and current housing patterns are inhibiting this development.

There is clearly a case for including more property in pension fund portfolios.

The practicality of investing substantial proportions of a portfolio in listed property or tying up money in management-intensive directly held property are perhaps major contributing factors for the low levels of institutional investment in property.

This can be alleviated by consolidation in the listed property sector, and listing property assets under institutional control.

Jaco Maritz is a senior quantitative analyst at Cadiz Financial Strategists