As investment professionals search for new ways to stabilise portfolios over the long-term, one asset class is proving to be a real boon. Owen Lennie, the newly appointed head of the Australian Direct Property Investment Association (ADPIA), details new research that adds weight to the property story.
Investors don’t like losing money. This might seem an obvious statement, but, curiously enough, by illustrating exactly how much people are averse to doing their dough behavioural finance psychologist Daniel Kahneman scooped the 2002 Nobel Prize for Economics.
Kahneman’s pioneering work showed emphatically that most people are happy to forego higher potential returns in order to lower their chances of losing the lot. Kahneman theorised that the dot com crash, and subsequent equity market volatility, provided a very painful dose of reality to investors — professional or otherwise.
Today, despite a recovery in global equity markets, many of those hurt by the crash are still making up for lost capital. Investors have mulled over the lessons of the tech wreck and the memory of loss has, without a doubt, fuelled the demand for ‘absolute return’ investments.
Beating the benchmark alone is no longer a good enough excuse for professional fund managers to lose money. The promise to make a positive return for investors whatever the market conditions, and over any period of time, has now become the norm.
Fund managers, consultants and super fund trustees have therefore had to rethink their asset allocation strategies to meet these tougher expectations.
New research conducted by Atchison Consultants has shown that one asset class can significantly reduce the probability of a negative return in any one year — direct property.
Commissioned by ADPIA, in association with the Australian Pacific Exchange, the Atchison report shows that a significant allocation to direct property in a diversified portfolio over the last 20 years would have greatly reduced the chances of an investor losing money in any one year.
For the purposes of this article we will use the 20-year data, a particularly appropriate investment period for superannuation funds. However, results over the last 10 years provide an even stronger case for including direct property in a portfolio.
In the study, consultant Ken Atchison compared the performance of Australian shares, international equities, residential property, listed property, Australian fixed interest, Australian cash, managed funds and direct property over the 20 and 10-year periods ending on December 31, 2004.
The direct property sector was further broken down into retail, office and industrial. Comparisons across different taxation regimes were made, as were allowances for the effects of management fees and costs.
As well as the benevolent effect of direct property on a direct portfolio, the main conclusions reached by Atchison were:
* returns from industrial and retail property have been strong;
* over the 20-year period, direct property provided the highest level of income return and the lowest volatility of income return; and
* the preservation of capital to provide for future income and growth is more probable with direct property.
The low volatility of direct property investments is a key feature of the asset class and its ability to add a solid counterbalance to the swinging mood of the stock market.
In the report, Atchison wrote: “Low volatility of property returns provided the returns are strong, mean the importance of timing purchases and sales are less demanding than in listed growth assets.
“High volatility means that total returns can be greatly diminished by poor timing of purchases and sales by investors, and adversely impacted by capital raisings of listed companies at high prices.”
Critics argue that the property market is much more volatile than it appears. If properties were valued daily in the same way equities are these critics argue, it is likely we would see the same kind price shifts as on the share market, and hence the same investment risks.
While there is some merit to this argument — daily valuation would undoubtedly add volatility to the property market — it remains a mute one. Annual valuation of properties is standard and likely to continue to be so.
Less frequent valuation is a feature of the property market: investors should use it for what it provides — stability in a portfolio.
Valuation frequencies aside, direct property retains its solidincome-generating power. Typically, income accounts for about 75 per cent of an investor’s return on property, with capital gains making up the remainder. With equities on the other hand, income fluctuates wildly depending on the stock and is most unlikely to rise above 50 per cent of a return.
With over $13 billion invested in the sector, direct property is an already sizable force, but Athchison's study makes a strong case for including a greater proportion of this asset class in a portfolio. According to Atchison, an allocation of up to 25 per cent of property in a diversified portfolio is easily justified. He estimates that, at most, super funds currently have a 15 per cent allocation to property.
While that property exposure can include listed property trusts, Atchison says these only make sense if liquidity is your prime investment driver — and for super funds with a 20-year investment horizon, liquidity cannot be paramount.
Owen Lennie is president of the Australian Direct Property Investment. Association (ADPIA).