Property funds typically have lower levels of volatility than equity-based funds, and this, combined with the fact that the asset class has performed so well in the last few years, has proven the value of property funds in a portfolio
Uncertainty has been one of the prevailing themes in investment during much of 2004. Equity markets became range-bound due to worries about booming oil prices, corporate health and economic growth in key regions such as Europe, Asia Pacific and the US. Bond markets have been subject to interest rate increases in key regions such as the UK, US and China, and in a recent sector report, Standard & Poor's fund analysts commented on a fall in global bond yields as economic data softened and oil prices rose.
Within this environment, property has been a relatively successful investment - and this is true whether it is direct investment through buying a piece of property, or investment in a fund that invests in property. Reports abound in the press regarding the breadth and extent of the increases in property values during the last few years, no doubt fuelled in the 1990s by booming corporate and economic growth. In regions such as the UK, property price growth in the past few years has been phenomenal, and a seemingly successful attempt to slow this growth has been one of the key drivers of the five interest rate increases since November 2003.
a success story
Investment in physical property has typically been seen as a safe haven for investors - bricks and mortar being a tangible asset that usually retains its value well. There are various avenues to property investment for investors. Direct investment can be made by purchasing commercial or private property directly, but this is a highly illiquid way of investment that requires a large initial outlay. For many retail investors direct investment will usually be limited to the purchase of a home, rather than as a broad investment strategy where there is little scope for diversification.
A more viable option is to invest in a fund that buys stocks of companies in property-related industries and that may even directly invest in physical real estate - usually commercial. This is a much easier and cheaper method of achieving diversification within a portfolio while also gaining pure exposure to property.
There are 49 funds that invest in property in the Standard & Poor's Offshore and International funds database. There has been a substantial increase in the number of property and real estate funds available in the last few years - only 35% of the funds currently available have a five-year track record. Standard & Poor's sector definitions for these categories state that the sectors contain funds that invest in shares of companies in property-related industries and/or that hold physical real estate such as development sites. Funds are distinguished into sectors according to their geographical region of investment and the regions covered by property funds are the UK, US, Europe, Asia Pacific ex-Japan and those that invest globally.
Property funds have generally provided excellent returns over the last one, three and five-year periods. Though the level of returns varies by region - as would also be expected of equity or fixed income-based funds - average returns of property funds has almost always exceeded those of a relevant country index over those periods. The five-year period emcompasses a time of extremely variable market conditions (and many equity-based funds are still recovering from the bear market), but over half of the property funds with a five-year track record have seen returns in excess of 100% over this period.
Property funds investing in Europe gained almost 42% during the year, compared to 23% for the S&P/Citi BMI Europe index. The best ranked fund during the year is the Henderson HF Pan Eur Property fund which gained over 48% - almost 13 percentage points higher than the worst performing fund in the sector. The last three months have seen average returns in the sector of around 14%. Of the combined universe of property funds in the Standard & Poor's Offshore database, eight out of the top 10 best performing funds over a year invest in European property. Three-year performances average 123.9%, which is more than three times higher than the Europe index. All Europe property funds with a three-year track record have gained more than 100% during that time.
winners and losers
The largest property-based sector contains funds that invest in the UK, though the offerings in the sector are dominated by a few management companies such as Friends Provident, Old Mutual, Irish Life International and Royal Skandia. Average returns in the sector over one year are around 22%, with the top fund achieving gains of 42.4%. During the same period, the FTSE-All share index gained 25.2% - unlike the Europe property sector which saw significant outperformance in property, these returns are broadly similar. Over three years, however, property funds have again outperformed the index by a significant margin - the average three-year gains of 67% were over twice that of the FTSE All-Share. This sector has seen significant growth in the number of funds available in the last five years - at that time there were only two funds in the sector but it now contains around 19 funds. The launch of these funds can probably be attributed to the breadth of the UK property boom during this time; as investors became wary of equity markets during the early part of this decade, property has become an attractive asset class for investment.
Property funds investing in the US have slightly outperformed UK funds over one and three-year periods, gaining 27% and 70.7% respectively. Over one year, this compares to returns for the S&P 500 of 15%, but much more stark is the level of outperformance over three and five years. The S&P 500 gained 8.2% over three years while all property funds in the sector gained more than six times that. The sector is relatively well established, with seven funds that have at least a five-year track record, and over this period the difference is even more extreme. While the S&P 500 has lost -11.2% over the last five years, the property US sector gained almost 125% on average.
The two smallest sectors are those investing in Asia Pacific ex-Japan, and global, containing four and two funds respectively. Though choice has slightly increased in recent years, this is still a fairly limited selection. These funds have, however, seen similar outperformance relative to equities as the other property sectors.
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