July 2016

By | 16th August 2016

Quantitative easing (QE) and low bond yields have provided significant tailwinds to the real estate equity sector. However, a game-changer was the implementation of the European Central Bank (ECB) Corporate Sector Purchase Programme (CSPP). The growth of negative yielding corporate debt has been dramatic post the announcement of CSPP with an estimated €445bn of negative-yield euro investment grade corporate bonds (total universe including sub-12 month tenor) according to Merrill Lynch data. The magnitude of buying pressure from the ECB (€8.5bn monthly including negative bond yields) exerts an unprecedented hunt for yield, particularly benefiting European property shares which provide a long-dated dependable income stream at a significant pick-up versus other available yield propositions.

The Trust’s benchmark rose a substantial 7.45% in the month, reflecting not only the underlying performance of pan European property equities but also the continuing strengthening of the Euro against sterling. We remind investors that the Trust’s assets and the benchmark are priced in Sterling, and therefore non-Sterling currency appreciation benefits the overall valuation (and vice versa). However regardless of the underlying asset positioning, the FX position is always in line with the benchmark which ensures that any alpha generation is not generated by currency positioning. The fund’s NAV rose 7.73%, 28bps ahead of the benchmark. However the share price rose only 5.7% leading to a slight widening in the discount.

We take no comfort in collapsing interest rates as it also manifests signs of increased central bank policy ineffectiveness. Furthermore the risks surrounding the “QE Infinity” trap are significant. Nevertheless we consider pan-European property shares to be one of the least “toxic” yielding asset classes trading on a 4.9% cash recurring earnings yield and a progressive 3.6% dividend yield.

Another incremental catalyst could come on 31 August when both MSCI and S&P will carve out Real Estate as a separate GIS sector (first addition since inception in 1999). This is likely to draw further focus on the REIT sector which has been amongst the top performing asset class over the years, whilst a stand-alone reporting will make underweight positions more apparent.

In the UK, after the initial pain of the Brexit vote, (sterling hitting a 31 year low and AAA rating stripped out) the prompt appointment of Theresa May as prime minister limited the political uncertainty and calmed markets. UK REITs bounced strongly since their lows reached, following the EU referendum result and the open-ended property fund redemption crisis. UK property companies reported solid, albeit backward-looking, set of interim results and reassurance in terms of letting and transaction activity since Brexit and their shares have been helped by 10-year gilt yields halving from their 1.4% level seen at the end of May.

Gearing in the fund increased slightly over the month. We added further to our German/Austrian residential exposure through our participation in the Buwog secondary placing.

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