Discovery Flexible Property comment - Sep 15
Portfolio review The third quarter of 2015 saw global markets characterised by further volatility as concerns around decelerating Chinese growth put pressure on commodity prices and commodity-dependent emerging market currencies. A broadly stronger US economy contrasted the brittle global backdrop, with unparalleled attention paid to the prospect of the US Federal Reserve (Fed) potentially raising rates at its September meeting, in what would be the first rate hike since the global financial crisis. As it turned out, the Fed decided to keep rates unchanged, citing concerns that the global economy was not yet strong enough to justify monetary tightening. On the domestic front, the South African Reserve Bank (SARB) followed through on its hawkish stance and hiked rates by 25 basis points in July, in a bid to anchor inflation expectations. Consumer inflation diverged from its recent upward trend, slowing from 5% in July to 4.6% in August, with the recent decline largely attributed to a drop in petrol prices. In September the SARB was more dovish and kept rates on hold, prompted by improvements in the inflation outlook due to falling oil prices. For the quarter, the portfolio delivered returns ahead of the benchmark and peer group average.
Portfolio activity Volatile market conditions over the period created relative valuation distortions and, hence, trading opportunities. Pivotal Fund, one of the sector's recent listings, underperformed materially over the quarter, creating an attractive opportunity for us to increase our exposure. In the larger-cap space, we acquired a position in Capital Property Fund on the back of newsflow related to potential corporate activity. Capital Property Fund has since resolved to no longer spin-off its offices - these assets, along with the rest of its predominantly logistics-focused portfolio, had been targeted by stablemate Fortress Income Fund. In order to fund these positions, we trimmed our exposure to Redefine Properties following a period of strong performance, aided by its inclusion into the FTSE/JSE Top 40 Index towards quarter-end. We also reduced our holding in Growthpoint Properties, given its muted growth prospects for the upcoming financial period.
Portfolio positioning With sector risks set to remain, we encourage investors to moderate return expectations relative to the exceptional levels achieved in recent years. That said, the contractual nature of lease escalations can continue to protect the sector's top line growth. Distributions are forecast to rise by more than 9% and 8% in 2015 and 2016, respectively - these levels remain well-above forecasted inflation. The fourth quarter's results season is likely to reveal those management teams that have been more astute in their portfolio positioning and, hence, also create opportunities for our stock-picking strategy to generate additional outperformance. Overall, despite the tougher climate, the combination of the abovementioned growth and a forward income yield of just below 7%, translates to an expectation that inflation-beating returns remain achievable from the sector over the medium term.