Overseas antidote to property gloom

As a survey reveals deepening pessimism over British commercial property, a New Star real estate fund focusing on investments outside Britain has found favour with AFI panellists.

The latest quarterly survey from Reita, an organisation promoting real estate investment trusts, made grim reading for British commercial property investors. More than three-quarters of Reita’s panel of 24 property and investment firms say market conditions are deteriorating, compared with 69% in May. One third of respondents say the environment has worsened “significantly”.

Such pessimism symbolises the sharp turnaround in sentiment on the sector over the past two years. Retail investors poured money into domestic funds as the IPD UK All Property index generated double-digit annual returns from 2002-6. The index even outpaced British equities over the course of 2006 with a return of 18%, compared with just 17% for the FTSE All-Share, according to Financial Express.

Investing in commercial real estate seemed a safe one-way bet – with an unbroken run of positive monthly returns stretching back to January 1993 – and data from the Investment Management Association show that retail investment in British property funds remained positive until last September. However, as credit conditions tightened, property funds began to mark down the values of their portfolios.

The IPD benchmark also started to fall, prompting speculative retail investors to sell out of property funds. Outflows hit £48m last October, before spiralling rapidly to £253m in November and £242m in December. Several firms imposed deferred redemptions or swung prices of their unit trusts to a bid basis to protect their funds and long-term investors.

The measures had the desired effect and retail outflows slowed significantly at the start of this year, even turning into an inflow of £21m in March. But despite their success in stemming the tide, managers remain cautious on the sector in the light of macroeconomic factors. Almost half the Reita panel expects Britain to suffer two consecutive quarters of negative GDP growth, compared with just 27% in May.

Kypros Charalambous, associate director at Barclays Wealth, and Sam Sibley, an investment manager at Beckett Asset Management, are avoiding exposure to British commercial property entirely. Both Adviser Fund Index (AFI) panellists instead favour New Star’s International Property fund – a mainly bricks and mortar portfolio focusing on investments outside Britain. The fund was selected 11 times across all three AFI indices during the May rebalancing.

“We started switching from the UK into international property in early 2007,” says Sibley. “The UK is not particularly attractive and, while there are lots of international property share funds, New Star does not have many direct competitors.”

Sibley holds the fund in all of her AFI portfolios, including a 5% weighting in the Aggressive index. She is positive on the fund’s Asia Pacific focus and the managers’ decision to keep a significant cash weighting (29.4% at the end of July) as they await suitable investments.

Sibley was also unperturbed by New Star’s decision to move the fund to a bid basis last month, in response to a small number of exceptional redemptions. The move received widespread attention but the firm was able to swing pricing back to an offer basis the following day. Charalambous, meanwhile, uses the £680m fund within his Cautious AFI portfolio. He began moving his property exposure away from Britain and Europe two years ago.

“We were early on rotation and have not suffered in the same way as many investors,” says Charalambous. “When we see spikes and huge inflows it makes us nervous.”

But while Sibley and Charalambous are positive on the New Star portfolio, neither panellist is actively increasing exposure to property as an asset class. Indeed, Sibley says she is likely to cut her allocation during the November AFI rebalancingThere are seven AFI property funds. New Star International Property, the most popular fund across the indices, has proved the most resilient since the onset of the credit crunch. According to Financial Express, the fund returned 3.84% in the 12 months ending September 2 compared with falls of over 20% for the remaining six portfolios.

Just one property fund – First State Asian Property Securities – joined the indices in May. Fidelity Global Property, Norwich Property and Schroder Global Property Securities were all ejected.

The Adviser Fund Index series

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/adviser_fund_index.html).