Ian Anderson: Another 10% yield year in prospect for property


After a 25% return in 2014, pundits are wary of the outlook for the JSE’s property sector in 2015. Grindrod CIO Ian Anderson is among them, but the manager of Nedgroup’s Property fund reckons double digit distribution yields are likely for the R1.6bn unit trust – partly because of confidence in his stock picks.

Property is a sector that’s had a fantastic run – almost 25% in the past 12 months, looking through your performance.  Is it going to continue in 2015?

It’s unlikely, Alec.  The issues that drove the sector last year were lower interest rates, lower bond yields, strong acceleration, and distribution growth.  Not all of those are going to filter through into 2015.  Importantly, the starting yield last year was significantly higher than this year.  Purely from a valuation perspective, we’re probably not in as good a place this year, as we were in last year.  Although the actual fundamentals and tax evaluations looks a little stretched this year.

You’ve adjusted your portfolio accordingly.  Looking at the breakdown of your portfolio, it’s interesting to note that there are certain stocks, which one would always expect to see in a property portfolio that just don’t exist in your fund.

That’s right.  We’re out there to find the value for investors and right now, we see very little value in the larger/more liquid stock.  Last year, there was a significant increase in institutional investment into the listed property sector.  Most of those large institutions can’t hold the smaller companies and so they just buy the larger companies.  The relative performance of those larger companies were significantly better meaning that their valuations now don’t look as attractive as the stocks that weren’t being bought by the institutional investors.

It’s still, quite a ballsy decision to leave high prop/resilient funds like that, out of your portfolio.

Absolutely.  We like those misses.  They have high quality portfolios, but there’s always the appropriate price to pay and currently, we think that yields of the low five percent is appropriate, particularly if we think that over time, interest rates and bond yields will normalise.  We’re still able to secure listed property investments on yields between eight and ten percent, which is far more attractive than buying a similar income stream.  It may not be the high quality portfolio that you get at high profit, but it’s still an income stream growing at a similar magnitude at twice the yield at inception

You manage Nedgroup Investments’ Property Fund.  Just take us through the mandate that you’ve been given.

The mandate is to invest in South African listed property, but it has a slightly different take on what we’re trying to achieve.  Primarily, we want to provide investors with a high level of initial income and right now, the Nedgroup Investment’s Property Fund is providing a significantly higher level of initial income, than the market is – almost 180 basis points above what you can get from the market.  That’s because we’re not in those low yielding, big stocks.  We’re in the higher yielding smaller stocks.  The second objective is to grow that income over time, and we do that consistently.  If you look at the rest of the sector, you’ll see that as the sector has changed over the years, some of that income growth has been consistent.  Mot because the underlying securities have done it inconsistently, but because the nature and the makeup of the sector has changed with the introduction of foreigners like NEPI and the introduction of modern income-paying securities like Attacq.

Looking at the Nedgroup Fund, we have a much more consistent profile of paying income to investors and growing that income above inflation.  Through that, we hope to achieve capital growth, as well.  There are three objectives: high initial income yield, income growth in excessive inflation, and long-term capital growth in excessive inflation.

Classical economic theory tells you that the higher the yield, the greater the risk.  Is that translated to this sector?

I would say that’s perceived.  If you look at the perceived quality of the property portfolios of the lower yielding stocks; most people want to own a piece of Canal Walk or a piece of the V&A Waterfront, and so the yields on companies that own that quality of property, are lower.  The differential today is far too wide.  Historically, the differential between the higher quality portfolios and the lower quality portfolios, have only been about one-and-a-half to two percent in yield.  Now, you’re getting to differentials of four, five, and six percent and we just don’t think that’s justified.  Hence, our move to sell the lower yielding and perceived higher quality portfolios, and to invest the proceeds into the perceived lower quality portfolios, but trading on much more attractive initial yields.

You mentioned NEPI.  Nearly one-tenth of your portfolio is tied up in that stock – investing in Eastern Europe.  I challenged somebody in the property sector recently by saying ‘have you visited Eastern Europe?  Have you gone to see what’s going on in the property market in Romania’ and I guess it’s a similar question to you.

Yes.  I haven’t made many trips to Romania, but I have been there.  I’ve seen most of their properties.  It’s not so much about what’s happening in the Romanian property market, as it is about what management is doing within the NEPI portfolio in Romania.  I’ve been involved in the listed property sector for over 20 years now, having started at Marriott back in the mid-nineties and the evolution of our property market through the 1990’s and 2000’s is that similar to what’s happening in Romania right now, it was a very fragmented market.  Very few people truly understood how much value you could extract from a high quality shopping centre.  More in Romania five or six years ago, was a Hypermarket with a few shops attached to it.  NEPI had gone in there and created the concept of a mall.  If you create a desirable location for your tenants, your tenants will come and they will do a good job of attracting your customers.

As a result, we’re seeing many retailers entering the Romanian market for the first time because there is a quality product for them to occupy.  I think we’re going to see more and more of that from NEPI over the next three to five years.  Although the initial yield is low, we anticipate growth of anywhere from 15 to 20 percent per year in earnings, as NEPI roll out this evolution for Romanian retailers.

That’s quite a compelling story.  One also has to buy into the country itself, because they might have the right strategy but if the country doesn’t perform…

Ultimately, it’s always going to come back to growth in the region. Property can only survive for so long through good management, but you need that underlying economic growth.  We also manage global property portfolios and one of the regions where we have a significant underweight, is Europe because we are very concerned about the fundamentals for the region as a whole.  We do look at it very closely.  The Romanian Central Bank cut interest rates by one-quarter of a percent, suggesting that there are problems in their economy but at least, policymakers there are trying to stimulate growth.

Your biggest holding though, at the end of December was Delta Properties.

Yes.  Once again, it comes back to the fact that we’re looking for the highest possible combination of income yield and income growth and right now, Delta is offering us a yield in excess of nine percent.  In fact, the forward yield on Delta today, is nine-and-a-half percent and that compares very favourably with the four’s to fives that you get from some of the larger companies.  We also expect that they can grow their distributions by around ten percent/year for the next three years as they also, roll out their expansion plans and reengineer their portfolios.  We remain optimistic about the prospects for property (generally) in South Africa, and we still see significant value away from the larger/more liquid companies.

It is interesting, given your reluctance to be heavily invested in the large cap stocks, that you do still have Redefine in there, as your fourth biggest holding.

Absolutely.  Redefine was one of the few large cap stocks that didn’t follow the rest of the sector last year.  In fact, it was an underperformer last year.  We have been lightening our position in Redefine.  When we were buying Redefine during the course of last year, we were buying it on yields of around eight-and-a-half percent.  Now, the forward yield on Redefine is getting closer to seven percent, so it’s about seven-and-a-quarter or seven-and-a-half percent.  We have also, recently seen them do a couple of transactions, which we know will be earning- and distribution-enhancing initially, and probably into the long-term.  They bought the lease – capital office portfolio -, which is predominantly high quality offices in the Western Cape.  Although we don’t currently like offices per se, that was a very good transaction for them.

They’ve done a deal in Germany as well: JB with Redefine International.  All of these things should stimulate growth in Redefine and we expect a rerating of that particular share, relative to its larger counterparts.

We’ve looked at your favourite stocks and your stock selections.  What about the market as a whole?  What are distributions likely to do in 2015, given the points that you made at the outset of this discussion (that valuations are stretched)?

Valuations are stretched, but I think it’s in anticipation of another strong year for distribution.  Between 2009 and 2013, the sector was only able to grow distributions around five, six, and seven percent, with seven being the very top end of the range.  However, last year, distribution growth was well in excess of ten percent and we would expect this year to see a similar number.  Resilient reported yesterday, anticipating growth in distributions of 16 percent this year.  One of the reasons why the market likes them so much is because you’re getting equity-like earnings growth and it’s very stable, and very reliable.  Nevertheless, we would still value a business like Delta or even Rebosis, far higher than we would Resilient right now, because of the attractive yield that we get.

Distribution growth is still going to be good in 2015, but currently, I don’t think it’s going to be good enough to support the valuations that we see, especially amongst the larger/more liquid companies.

What kind of investor should come into the Nedgroup Property Income Fund?  How long should they be looking to hold on?

Although there’s a strong income element to an investment into a property fund, there is quite a bit of capital volatility so the minimum investment period should be years.  Ideally, it should be five years and longer if anyone is looking for either income, or capital growth.  That probably covers the entire spectrum of investors.  It’s not a parking bay for a three-month or six-month pot of money before you do something different with it.  It offers significant diversification benefits, particularly in an SA multi-asset portfolio.  The correlations between listed property and equities have been falling consistently, since 2005 to 2006 and in fact, the two asset classes are now almost uncorrelated.  That means that adding listed property to a balanced portfolio does a far better job of diversifying the risks than say, going into offshore equities where the correlations with South African equities have been rising for the last five or six years.

If you were looking at constructing a multi-asset portfolio, we would seriously recommend at least a ten percent allocation to listed property, through our time.  Ten to 15 percent would be a standard allocation to listed property and obviously, when valuations look good you can take it as high as 25 percent, which is where we currently have many of our balanced funds positioned because we still see value in the smaller companies.  If you’re a large asset manager or if you’re a large institution and you’re currently only investing in the larger listed property companies today, then I would obviously pull down my current allocation to listed property, to below 10%.

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