The care home sector exhibits low correlation to other assets, low volatility and sustainable income
The global financial crisis created a paradigm shift in the perception of risk. The unprecedented collapse of most traditional asset classes prompted investors to look further afield for truly alternative forms of investment, immune from the short-term impact of market movements.
Additionally, the subsequent low interest rate environment has also resulted in a major quest for income, driving the prices of many yielding assets well above fair value. Nets have been cast far and wide as investors sought to address these issues.
The care home sector, a relatively unknown but growing space, remains the preserve of a small band of investors. But it is now being increasingly recognised for its low correlation to other assets, its low volatility character-istics, and its high and sustainable level of income.
The care home sector’s emergence as an alternative form of investment is underpinned by attractive and indisputable demographic trends, such as longevity and an ageing population.
The macro demographics are irrefutable. The number of people in the UK aged 85 and over – 1.6 million in 2013 – is set to double over the next 20 years. From 2012 to 2032 the populations of 65-to-84-year-olds and the over-85s are set to increase by 39 per cent and 106 per cent respectively.
Based on government actuary projections, the number of people living in residential care in the UK will increase to 1.25 million in 2056 compared with 419,000 in 2009. It is difficult to find a more invariable and global tailwind than the ageing population.
At the very time when the requirement for residential care provision is being driven upward by demographic change, the total capacity in residential care homes has actually declined over the past decade.
The supply/demand imbalance offers unrealised investment opportunities and significantly underpins the asset class.
The sweet spot for investing in care is with the operating companies, which are both the providers of care and owners of the real estate. The leading operators are creating profit levels in the region of 25-28 per cent for care provision, with gross fees being linked to RPI.
In addition, the requirements to provide the capital and have the appropriate specialist regulatory experience have created high barriers to entry in the sector. This supports such high return levels.
Such a solid level of return helps to provide a high and inflation-proofed income stream for investors, which is currently producing a running yield in the region of 8 per cent. In the present low interest rate environment, high and predictable income levels are a rare commodity. The sector is especially favourable when compared with other alternative assets, most of which produce no income at all.
The valuation of care homes is driven by the net fees generated by each bed rather than property market dynamics, thus insulating returns from any correction in the property, bond market or equity markets. However, there remains a real estate value underpinning any portfolio, which acts as embedded risk support.
Consequently, the return stream from the care home sector looks very different from any equity, bond or alternative asset and more closely resembles an inflation-linked, high-yielding liability such as a pension or endowment. The chart below illustrates the low level of correlation between a care home operating fund and key equity, bond and property indices.
The ageing population and the increasing requirement for residential care provides a degree of predictability not afforded to other asset classes. Care sector dynamics are unlike any other form of investment, demonstrating that alternatives can not only offer uncorr-elated returns, but can also provide a high and sustainable level of income.
Key takeaway Until now the preserve of the few, investors searching for income and a low correlation to other assets may want to consider the care home sector.
Oliver Harris is managing partner at Montreux Capital Management