Updating the ‘total return quilt’

Chris Bedingfield

Quay Global Investors

The year 2020 was extraordinary for most risk assets. As we wrote in last month’s Livewire, the unprecedented fiscal response to the pandemic caught some investors wrong-footed.

Total return (AUD) by sector by calendar year

Notes: Global Infrastructure: S&P Global Infrastructure Index Net TR, Global Property: FTSE EPRA NAREIT Dev TR, Aust, Equities: S&P/ASX200 Accumulation Index, US Equities: S&P 500 Total Return Index, Gold: Spot Gold, Global Equities: MSCI World Index, Fixed Income: Bloomberg Barclays Global Treasury Total Return Index, A-REIT: S&P/ASX 200 Listed Property Fund, Aust Small Cap: S&P/ASX Small Ordinaries Index

Some asset classes and sectors performed well. Some, including global real estate, lagged. As most risk assets continue to spiral ever-upwards and relative performance becomes even more stark, we thought it was a good time to think about various asset classes, their performance, and some historic perspective.

In prior LiveWires, we have referred to the ‘return quilt’, which has been ranking nine risk asset classes each calendar year since the beginning of the century. The returns are all in Australian dollars (see previous tables).

In 2020, based on our select group, Gold was a clear winner, along with Australian small caps, US equities (tech driven) and global equities. At the other end of the spectrum, domestic listed real estate (REITs), global unhedged infrastructure and unhedged real estate performed poorly.

As discussed in recent monthly performance reports, the underperformance of listed real estate is very much a function of direct government intervention, relating to certain ‘codes of conduct’ and moratoriums on tenant eviction.

However, taking a wider perspective of asset class performance by year highlights that sectors that perform poorly in one period rarely continue that underperformance. Of course, mean reversion plays its part; however, it is worth remembering that over the past 21 years:

  • Global real estate finished the year in the top four for 15 of 21 years
  • This compares to the much more popular global equities (5), Australian equities (10), and US equities (12)
  • Global real estate and domestic REITs ranked highest on six occasions
  • Compared to global equities (zero), Australian equities (zero), US equities (twice)
  • Although global real estate has ranked low in prior years, the sector often recovers over the following years, ranking among the highest in the selected peers
  • Global real estate ranked relatively high during the recovery years of the GFC (2009-2012) and the ‘tech wreck’ (2002-2004), belying the idea it is a ‘late cycle’ asset class.

The accumulation of these observations is that global real estate total returns (unhedged) have delivered a credible performance so far this century.

Source: Bloomberg, Quay Global Investors

These returns should also be viewed in the context that over the past 21 years, real estate has disproportionately suffered through a pandemic and a (admittedly self-induced) financial crisis.

Dimensioning these returns against volatility (a crude measure of risk) suggests global real estate ranks mid-level. So, while investors may have to stomach more volatility compared to, say, global equities, they get compensated for that risk.

Source: Bloomberg, Quay Global Investors

Other general observations

Critics of this paper may suggest that since 2000, listed real estate has had an unfair advantage compared to other asset classes due to the steady decline in interest rates. However, as we have previously written, listed real estate is not particularly correlated to interest rates over the long term. In fact, the recent recovery in global listed real estate has coincided with a steady increase in bond yields.

Another argument is the potential impact of moving from a low inflation environment (2000-2020) to high inflation (+2021?). However, historically REITs significantly outperform equities during periods of high inflation.

The last half of the 2020s have been the worst period for global real estate, which can largely be explained by the sharp decline of retail property values since 2016 (retail accounted for almost 30% of the global index in 2015). This sector headwind is now behind us (as it is just 14% of the index today), and in some cases there are real opportunities in retail.

But the overall lesson is the same as with most forms of investing: patience. It can be tempting to allocate to sectors that are currently performing well, but when it comes to global real estate, mean reversion and a proven high-quality asset class means good relative performance is likely in the years ahead.

Investing in global listed real estate

Quay, a Bennelong Funds Management boutique, focuses on the preservation and creation of wealth through innovative strategies in real estate securities. For more insights on global property, visit Quay’s website.

Revisiting REITs and interest rates 5 It is interesting to note that the past 20 years, when interest rates have mostly declined and central banks have employed significant levels of quantitative easing, PE change has not accounted for much total return at all. Rather, earnings growth and dividend yield has accounted for the lion’s share of returns over the past twenty, fifty, hundred years. In equities – and in REITs, no less – the key to explaining returns lies in company earnings. Conclusion As markets continue to navigate the risks of COVID and a potential vaccine, investors are rightly beginning to focus on the risks associated with the massive stimulus put in place during 2020. One of these risks is inflation and the potential for higher interest rates. But, despite a long-held belief that interest rates influence REIT total returns, there has been a total breakdown in the correlation between REITs and the US 10-year bond yield this year. While there are indeed short periods where correlation is high, over the long term there is no relationship between REIT returns and interest rates. At Quay, we have found replacement cost and earnings growth have explained REIT returns far better. This makes sense, given REITs are nothing more than real estate businesses operating in a commodity market. With this in mind, we believe it is a better use of REIT investors’ time forming a view on earnings, rather than interest rates. While we have top-down opinions, it is our bottom-up research process that matters. For more insights from Quay Global Investors, visit quaygi.com The content contained in this article represents the opinions of the authors. The authors may hold either long or short positions in securities of various companies discussed in the article. The commentary in this article in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader. This information is issued by Bennelong Funds Management Ltd (ABN 39 111 214 085, AFSL 296806) (BFML) in relation to the Quay Global Real Estate Fund. The Fund is managed by Quay Global Investors, a Bennelong boutique. This is general information only, and does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units in any fund of which BFML is the Trustee or Responsible Entity (Bennelong Fund). This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser. You should also consider the relevant Information Memorandum (IM) and or Product Disclosure Statement (PDS) which is available on the BFML website, bennelongfunds.com, or by phoning 1800 895 388 (AU) or 0800 442 304 (NZ). BFML may receive management and or performance fees from the Bennelong Funds, details of which are also set out in the current IM and or PDS. BFML and the Bennelong Funds, their affiliates and associates accept no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. All investments carry risks. There can be no assurance that any Bennelong Fund will achieve its targeted rate of return and no guarantee against loss resulting from an investment in any Bennelong Fund. Past fund performance is not indicative of future performance. Information is current as at the date of this document. Quay Global Investors Pty Ltd (ABN 98 163 911 859) is a Corporate Authorised Representative of BFML.

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Chris Bedingfield
Principal and Portfolio Manager
Quay Global Investors

Chris has nearly 30 years of experience working as a real estate specialist, with a background in investment banking and equities research. Prior to co-founding Quay, he worked in real estate investment banking at Credit Suisse and Deutsche Bank.

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