What to expect in terms of property fund performance

But he says investors should be aware that investment in and out of funds can have an impact on performance where excess cash dilutes returns in a rising market or, conversely, where the manager is forced to sell illiquid assets in poor markets to meet redemptions.

The impact of these factors is reduced in the case of professional funds, compared with retail investor funds, where the manager may limit capacity in strong markets and defer redemption payments in weak markets, Mr Ludlam adds.

He says: “Funds which invest in global property securities will behave differently from UK property, and offer the benefit of further diversification within an investor’s overall property holding.

“Property returns are largely driven by local factors which may vary across the globe, so while we experienced relatively weak returns in the UK from 2011 to 2012, the performance of US property markets was significantly better.

“In addition, the share price performance of listed companies has historically led physical property markets by nine to 12 months, and this further helps smooth property portfolio returns for portfolios which include both listed and physical property funds.”

Ainslie McLennan, manager of Henderson UK Property Oeic, says when looking at performance it is clear that property should be considered a long-term holding.

While property shares tend to be sensitive to the prevailing market and economic conditions, Mr McLennan says leases on the underlying property holdings can help to dampen volatility.

If there is a long time to go on the lease and the company renting the property is financially strong, Mr McLennan says this can create greater predictability around the security of the long-term rental income.

Property is also a tangible asset – something physical that can be used. While a share could become worthless if a company goes out of business, Mr McLennan says buildings and land are still valuable assets.

He says: “High-quality structures in good locations are more likely to hold their value in a challenging economic environment.

“Unlike other asset classes, a property fund manager can utilise asset management strategies to enhance the income and capital returns from commercial property assets.

“This can include refurbishment work to improve valuations and attract a better quality of tenant, changing the planning use of assets to increase rental revenue, or re-negotiating existing leases to extend tenancies.”

Assessing performance

Hugh MacTruong, proposition manager of Legal & General Investments, says it would be wrong to make a sweeping generalisation about how property performs in different market conditions.

He says property funds have different strategies; they can be balanced, specialist, defensive or opportunistic. As such, it is difficult to make meaningful conclusions on relative performance without analysing each fund in turn.

Mr MacTruong says this is why research should play such a key role in the fund management process.

He says: “Of particular interest, however, is the relationship between property capital values and retail fund inflows; there is a very high correlation between the two.

“So as values rise so do fund inflows and the requirement to deploy capital. The opposite can also be true – as prices soften retail outflows will increase. This can sometimes lead to requirements to sell into softer market conditions.”

In recent times, Eugene Philalithis, portfolio manager at Fidelity Solutions, says the best opportunities in physical property have been located beyond the major cities, where high quality buildings can generate steady income.

Mr Philalithis says the ‘prime’ property market, most notably London property, has seen a spectacular increase in value since the financial crisis, but values outside these areas have been falling until recently, meaning yields have been rising.

He says non-prime yields have now risen to such a degree that the premium over 10-year gilts was a staggering 887 basis point in September 2013, according to CBRE.

Mr Philalithis says there is a similar pattern in the core Eurozone markets of Germany, France and Benelux, but the gap in the UK is the widest of any developed property market in Europe.

He says: “One question I’m often asked is whether I consider property to be a growth asset or a more like a bond substitute. From an investment standpoint, I classify assets based on the behaviour of their income and capital during the economic cycle.

“With this in mind, I consider property to be a growth asset because of its pro-cyclical capital behaviour and inflation-linked income.

“However, it is important to recognise that the split of returns between income and capital varies depending on geography.

“Western European markets are much more bond-like in their behaviour, historically delivering around two-thirds of their return from steady, relatively predictable income. So, in that respect, they are ideal for an investor looking for regular income.

“The de-rating of the secondary sector, which began in 2007, is extended, with the consensus view being that many assets, particularly those with exposure to retail, are structurally challenged by the internet.

“However, due to the lack of supply and rising investor confidence, it is likely that rental and capital growth will be stronger than expected and that this opportunity will continue for a while yet.”