Think global to capture alpha

Australian investors have a long history of investing primarily in domestic listed property and largely ignoring the global listed property market.

This is understandable given their familiarity with the Australian listed property trust (LPT) market and its track record of attractive and comparatively stable returns.

However, structural changes in global listed property markets are making them more attractive as a place to invest.

In particular, the newer international markets tend to be less efficient than the Australian market and, accordingly, produce higher returns.

Importantly, there are a variety of different active investment styles for global listed property investment. This enables a multi-manager approach to global listed property to provide investors’ portfolios with higher excess return — or ‘alpha’ — potential at lower risk or volatility through investment style diversification.

Australian listed property has changed its stripes

Until around five years ago, the Australian LPT market was essentially a property investment that happened to be listed on the Australian Securities Exchange.

However, trends in recent years have significantly changed the LPT market’s characteristics.

A key trend has been with respect to ‘stapling’. This is where traditional property investment vehicles are combined with property companies that rely on development, management and other income.

A notable example is the formation of the Westfield Group from the combination of Westfield Trust and Westfield America Trust with Westfield Holdings.

The Australian LPT market has also witnessed a marked increase in debt levels to around 40 per cent of assets, versus around 10 per cent a decade ago. The result has been more volatile earning streams.

The recent Centro Group collapse and increased share price volatility across the sector are symptomatic of these higher debt or gearing levels.

As the Australian LPT market has become more ‘equity-like’, it is now less effective as a surrogate property investment and a diversifier in portfolios.

In terms of pursuing excess returns from active management, this is always more successful in investment markets that are less efficient and contain a greater breadth of geographic and sub-sector opportunities.

In this regard, the Australian LPT market compares poorly with global listed property, as the domestic LPT market is narrow in scope and heavily scrutinised by institutional investors.

Indeed, the Australian market is among the most efficient in the world — an undesirable trait for active investors.

Further, most property considered ‘institutionally investable’ is already held in investment portfolios, limiting the scope for companies to create value through acquiring new, attractive properties.

Greater investment opportunities

Fortunately, global listed property offers an attractive alternative to the Australian LPT market.

The key feature of global listed property is the ongoing trend towards listing property on stock exchanges and the opportunities this activity provides investors.

Introduction of an investment structure similar to Australian LPTs, called real estate investment trusts (REITs), has been the trigger for an expansion of listed property beyond North America and into Europe and Asia.

Figure 1 on page 24 shows a timeline of the introduction of REITs in countries, plus a list of those where REIT structures are currently under consideration.

These vehicles have similar characteristics to Australian LPTs: liquid publicly traded securities, with core property as the predominant underlying assets, plus relatively high dividend yields (especially on a hedged basis).

Relative to the Australian LPT sector, global listed property offers a much broader universe with less concentrated exposures (see Table 1 and Figures 2 and 3 on page 25).

Currently, there are 22 countries in the global benchmark, the FTSE EPRA/NAREIT Index. There is a wider range of sectors and securities.

Meanwhile, the Australian universe is heavily weighted towards the retail sector (47 per cent directly, plus additional exposure within the diversified sector).

The top three stocks in Australia comprise over 50 per cent of the universe.

In such concentrated universes, a significant event in any one of the 34 stocks in the S&P/ASX 300 Property Index can have a disproportionate impact on the overall asset return, which is what happened with the Centro Group.

The ongoing trend towards listing property on stock exchanges under REIT structures is boosting potential for excess returns from active investment in four ways.

1. The breadth of opportunities is increasing as the investment universe moves from being US-dominated to offering a wider range of countries, sectors and securities.

2. Greater choice of countries and sub-sectors increases the scope to actively manage through property cycles that can be country-specific in nature.

3. Newer markets tend to be less efficient, and prone to mis-pricings that may result in higher returns.

4. There is potential to participate in the flow of new issues, and capture new listing premiums.

Russell Investments expects these four sources to support additional excess returns of over 1 per cent per annum from global relative to Australian listed property managers.

Reasons for sticking with local listed property

A potential benefit of Australian LPTs over global listed property relates to tax.

Australian LPTs can offer taxation advantages relative to global listed property, reflecting elements such as tax-deferred distributions, franking credits and the like.

Tax can be horrendously complex, and investors should seek to understand it given their own circumstances.

Two points are worth making.

First, rough calculations suggest that for many superannuation funds, the tax difference in favour of Australian versus global listed property should be less than 0.3 per cent per annum.

Second, for tax-paying investors, the impact is likely to be greater the higher the marginal tax rate.

Investors must determine whether these modest ‘tax-driven’ benefits of Australian LPTs are sufficient to compensate for the clear ‘investment’ benefits — with respect to pre-tax returns, sub-sector/issuer diversification and risk control — of global LPTs.

The multi-manager approach

Multi-manager portfolios blend managers with complementary investment styles and skills, leading to more reliable alpha generation.

Multi-manager funds also perform functions such as manager research, manager selection and administration on behalf of financial planners and their clients.

By ‘outsourcing’ these functions, planners can spend more time focusing on their clients’ long-term wealth management needs.

The advantages of a multi-manager approach are particularly relevant for global listed property.

Locally-based investors often have limited capacity to research and access individual managers operating across global markets.

Multi-manager funds are well placed to select and invest with the best global listed property managers on the investor’s behalf.

In addition, manager blending can be even more effective in global markets.

Multi-manager portfolios may be designed to capture not only various security selection styles such as value or growth, but also country and sector selection capability.

The latter can be especially useful in the case of global listed property, given the importance of geographic and sectoral influences.

Changing times for listed property

The traditional role of Australian listed property should be re-evaluated. A change in the nature of the sector makes it less suitable as a surrogate for direct property exposure.

If the objective is pursuit of active returns, recent developments establish global listed property as a serious and arguably superior alternative to a local market that offers less return opportunities.

In the absence of a clear tax-related or other reason not to do so, investors should consider going global in listed property.

Furthermore, multi-manager funds can offer an effective way to get access to well-diversified portfolios of the best global listed property managers available.

Patricia Curtin is the director of the investor services (intermediaries) group at Russell Investment Management.