Performance volatility and concentration issues continue to plague the Australia real estate investment trusts (A-REITs) sector, but it can still play a key role as a portfolio diversifier.
According to Morningstar's recent sector wrap-up, listed property funds are now characterised by healthier balance sheets, reduced gearing, divestment of offshore assets, more sustainable payout ratios, a return to traditional rent collection and the potential for continuing high and comparatively stable income.
Despite this, most funds are highly concentrated, relative to other asset classes, at the individual stock and sub-sector levels as well as in the number of stocks, the report stated.
For example, the Vanguard Property Securities Index accounted for 91.95 per cent of the total A-REITs index as at 30 June, with Westfield Group continuing to make up under a third (28.67) per cent of the portfolio.
Morningstar suggested any allocation to listed property should be in a supporting capacity and mainly for investors targeting income or in the drawdown phase, with an allocation of around 10 per cent for both Australian and global REITs.
"Investors with a more income-focused orientation may look to prefer A-REITs, while those seeking a greater growth profile may lean towards global property," the report stated.
"Although some fund managers have broadened their eligible universes to include infrastructure and property-related stock, any further reduction in sector constituents could critically impair fund managers' ability to build portfolios of investable stocks," it said.
With most funds hugging the index, the report found that a "smaller fee hurdle can be a substantial and sustainable competitive advantage over time" for A-REITs, and the ratings reflect this conviction.
