Property remains a long-term source of inflation protection

With UK 10-year gilts currently yielding roughly 2.6 per cent, property funds look attractive as they can offer upwards of 4 per cent, with less of the volatility of equities.

As the Bank of England has pledged not to raise the bank rate until unemployment falls to 7 per cent, which they forecast will not happen until the end of 2016, this trend shows no signs of abating as many multi-managers are in the “lower for longer” camp on interest rates.

Meanwhile, the UK economy has been going from strength to strength, with a growth in gross domestic product of 0.6 per cent in the second quarter, a positive factor for commercial property which is starting to see prices move back towards their pre-crisis levels.

Justin Onuekwusi, multi-asset manager at Legal & General Investment Management, has made property funds one of the key components in the L&G’s recently launched multi-asset, risk targeted range.

“In this low yield world, with bonds [yields] at such low levels, investors are finding other ways to get income, and property is one of those areas,” he says. “We think the yield it gives for the risk you take is very attractive... and it’s a great diversifier.”

The manager invests in the asset class in-house through L&G’s £920.7m property fund, which at the end of August offered a yield of 2.9 per cent.

But he adds that the main issue he has with property is its illiquidity. “We typically won’t put more than 10 per cent in our portfolios simply because of the liquidity - if it was not for that I would have more in my portfolio,” he explains.

Furthermore, Mr Onuekwusi points out that the cost of getting in and out of property could be as much as 6-7 per cent, which has to be factored in to the decision to invest.

“Given the transaction costs it [property] is still sort of attractive but the key is you have to be holding it for the long term, I won’t go in and out of property in the short term because of that cost,” he says. While the manager is keen on the asset class in general, he prefers to invest in the asset class through open-ended funds, as he doesn’t think Reits (real estate investment trusts) are an ideal way to gain exposure, because they experience higher volatility than direct property as they are more strongly correlated with equities.

Simon Evan-Cook, who manages Premier Asset Management’s multi-asset funds, has also become increasingly positive on property.

“We have not held open-ended property [previously] but in the past few months we have gone from having nothing to 7-8 per cent in the income funds,” the manager says. He adds that property now accounts for 13 per cent of the £223.6m Multi Asset Distribution fund.

“It has only been an income story for the past five years or so because prices have not done much at all. We think it is continuing to see a decent income,” Mr Evan-Cook says.

He is reassured by the fact that property prices are back to relatively low levels, so thinks they are unlikely to fall.

“I didn’t want to earn the income and see the value of the asset class deflate,” he explains. “We are not expecting a boom but it’s a sound investment.”

The manager notes that not only does a property fund offer a competitive yield, it is also less susceptible to inflation.

“It’s quite an attractive income stream that could rise to protect you against inflation, which a gilt does not have and is very important to us,” he says.

But while Aberdeen Asset Management’s multi-manager team has been exploring the possibility of adding some property funds to its portfolios, the costs are still giving it pause for thought and it currently has no exposure.

“We could see a case for using property funds to generate yield in the future, but when is open to debate,” Scott Spencer, senior portfolio manager on the team, says. “We are still getting quite good yields from bonds and equities. Costs are a big issue, [property funds] may look attractive but it can have a significant impact in the short term.”

Property funds have been out of favour in the past few years as investors were mindful of the price crash in 2007-08, which served as a reminder that it is a fairly illiquid asset class which can be hard to sell quickly. There are also high transaction costs involved with property.

But for long-term investors, property is a compelling way to diversify your portfolio and provide income that also offers some inflation protection.

Eleanor Lawrie is news reporter at Investment Adviser

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MANAGER VIEW

Philip Nell, manager of the Aviva Investors Property Trust, provides an overview of the UK property sector:

“Capital growth was significantly more positive in the third quarter for the market overall. For now, yield compression is the major driver of the turnaround and the near term is likely to see this trend continue, especially in the higher yielding parts of the market. There are also growing signs of broad improvement in occupier market fundamentals and we expect this trend to continue in coming years and one which should sustain the recovery in real estate returns beyond the near-term yield-driven rally. As a result, we expect UK real estate in aggregate to deliver robust returns on a sustained basis in coming years.”