Fund manager SG Hiscock has shifted its listed property securities fund to a defensive stance, in response to the late cycle environment. Surprisingly, it favours retail REITs.
Grant Berry, portfolio manager of the SGH Property Income Fund, says the A-REIT market is “very late in the investment cycle”, with higher risks emerging.
Capitalisation rates for office retail and industrial property are lower than they were in 2007, before the GFC disrupted the A-REIT market. “Cap rates” are a measure of value, usually calculated as the ratio between income produced by a property and the current valuation (or original cost). Low cap rates indicate highly valued assets.
Berry says SG Hiscock is positioning the Property Income Fund in defensive, high quality assets that have less exposure to economic cycles.
Berry says office is the most cyclical sector and retail is the least. This is because office demand is more volatile and new supply can be built in two or three years. With retail, there are high barriers to entry because it is hard to find locations for new shopping centres.
He says industrial property sector cap rates have come down the most, leaving the sector most exposed.
Berry says: “Shopping centres occupy large footprints in urban locations, with tight planning requirements.”
And despite all the concern about the sluggish retail sector, shopping centres have a highly diversified income base.
The fund takes a “benchmark unaware” approach and instead targets a return of the consumer price index plus 3 per cent. Over the 12 months to the end of August the fund returned 9.4 per cent net of fees, compared with CPI+3 of 4.5 per cent.
The S&P/ASX 300 A-REIT Accumulation index was up 19.8 percent over that period.
The fund paid a distribution yield of 9.5 per cent over that period but lost 0.1 per cent of its capital value.
Over the past 10 years it has returned 12.6 per cent a year, compared with 5.1 per cent a year for CPI+3.
The top holdings in the portfolio include Scentre Group, Vicinity Centres, Stockland Property Trust, Unibail-Rodamco-Westfield and Charter Hall Retail.
In a review of the REIT sector in May, Macquarie Securities described retail as “the sector’s trouble spot”.
“We believe the cash flows being generated by retail REITs remain under increasing pressure. Trading updates for the March quarter were soft, with sales slowing to 1.6 per cent – down from 2.1 per cent in the December quarter.”
Berry concedes that retail is “the unloved sector” but says there are some signs of improvement in consumer sentiment, driven by factors such as lower interest rates, tax cuts and the beginning of a pick-up in the housing market.
He says Amazon’s entry into Australia was over-hyped and has not had a huge impact to date. “What we are seeing is faster growth in multi-channel retail distribution rather than pure-play online”.