SMSFundamentals | Oct 24 2013
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By Greg Peel
After experiencing stronger than expected returns from capital markets during the first half of 2013, a substantial number of institutional investors are re-evaluating their portfolios as they wait for central banks to tighten monetary policies, AMP Capital has found. It is not simply a matter of abandoning bonds and equities in the face of eventual reductions in quantitative easing and subsequent interest rate increases, but rather investors are fine tuning their approach. Many are seeking appreciation from capital growth combined with yield from new and different sources, AMP notes, supplemented by better risk reward profiles. Capital preservation remains a focus.
Overall, global institutional investors presently have around a quarter of their portfolios allocated to foreign equities (or global baskets) and a fifth devoted to domestic stocks, with similar percentages invested in foreign and domestic bonds. At this stage, less than 10% of average portfolios is allocated to alternative assets such as real estate, infrastructure bonds, hedge funds or private equity. But looking ahead, more assets are expected to shift out of public markets and into alternatives such as “real assets” that combine yield with the opportunity of capital growth.
After several years of financial turmoil, Europe is shaping as a preferred investment destination, given attractive valuations in the region. Investors are likely to reduce their fixed income holdings, AMP notes, especially in government and investment grade corporate bonds, and instead invest in infrastructure, direct real estate and private equity.
It is not just institutional funds managers looking to step up exposure to direct property investment. In Australia, Charter Hall’s second direct industrial property fund (DIF2) has now closed, oversubscribed, raising $135m. The fund opened in December 2012 and was not expected to close until December 2014. DIF2 is spread across five assets and features diverse locations, income secured by long leases, quality tenant covenants and modern industrial facilities with low capital requirements. Australia Post, Coles and Toll Holdings feature among the tenants.
Over 70% of fund flow into DIF2 is attributed to self-managed super fund and high net worth investors.
“Institutional investors, SMSFs and high net worth individuals are becoming increasingly aware of the benefits of moving their investments from cash and term deposits to direct commercial property, says Charter Hall’s direct property division head, Richard Stacker. Stacker notes that in less than three years, yields on term deposits have halved. “Investors are on the search for yield and direct commercial property is a clear alternative”.
Some 77% of the respondents to AMP Capital’s institutional investor survey indicated they now favour capital growth over yield which, as AMP notes, is a major shift from recent years when assets generating cash yields were among the most preferred allocations globally. Only 23% favour yield above capital growth over the next three years.
Growth-oriented investments have already provided solid returns over the past year, AMP notes, such as US and global shares and selected property, while returns from bonds and cash have slowed. The trend towards growth has become strong even as recessions have continued in Europe, China has slowed and fiscal problems have beset the US. These issues have been offset by continued net global economic growth, reasonable profit growth for large enterprises, and the European Central Bank’s policy to “do whatever it takes” to defend the euro, AMP suggests. Meanwhile, Japan is undergoing a significant sea-change under reflationary policies that are the most aggressive in twenty years.
In seeking both capital appreciation as well as consistent yield, investors are turning to direct real estate, private equity, direct infrastructure and infrastructure debt. The greatest institutional demand in the third quarter was for direct real estate. Of course, warns AMP, returns are dependent on the type and location of property investment. As to whether direct property investment growth will continue once the Fed begins to taper QE is a case in point, as eventually interest rates, and thus debt costs, will rise. But given QE tapering is expected to only be gradual and driven by an improving US economy (and now likely at least six months away on timing), AMP does not expect too great an impact.
AMP notes the US is the global bright spot for property investment. Europe remains slow but London is showing improving rental growth, while 20 years of stagnation in Japan means Japanese property is far from bubbling just yet. Conditions in Australia remain weak, but the country’s high yield is still very attractive to institutional investors, AMP finds.
This attraction also leads to Australian corporate bonds, which have returned a net 7% over the decade to the first of January, 2013, thus outperforming other developed markets tracked by BA-Merrill Lynch bond indices.
Private debt markets are rising in popularity, despite the risk of illiquidity. Investors likely perceive private debt issues as less vulnerable to rising interest rates, AMP suggests. There is a substantial level of interest in infrastructure debt, which offers inflation protection through government contracts. Some 42% of survey respondents said they are somewhat or very likely to invest in infrastructure debt over the next two years.
This trend also explains increased interest in listed infrastructure funds, AMP believes, which combine the capital appreciation potential of stocks with the attraction of solid yields.
With equities having rebounded solidly over the past 18 months, sophisticated investors are turning to alternatives such as hedge fund investment to maximise returns while securing downside protection in case of another turn for the worse. Most sought after are long-short funds, with investors preferring single managers to funds-of-hedge-funds.
In summary, AMP Capital’s findings support the notion that the secular trends of the last decade appear to be reversing. Developed market shares appear to be rebounding, whereas emerging market shares do not. Commodity prices appear to have peaked under the influence of slowing Chinese growth. The last six months have seen an improvement in investor confidence towards share markets. But coming from a low base, it is a long way from the excessive optimism associated with market tops. While US equity mutual funds have seen inflows this year, they will have to see a lot more before the $556bn in outflows seen over the previous five years is reversed. Conversely, bond funds have a long way to go before the $1.1 trillion in inflows seen over the last five years is reversed.
So we are not witnessing a wholesale exit from the traditional asset classes of stocks and bonds. What we are witnessing is a tweaking of investor risk/reward and capital/yield balances ahead of a new frontier of post-QE uncertainty.
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