Investec Property Equity Fund comment - Sep 12
Market and portfolio review The global economic backdrop remains weak and the prospect of a period of substantially lower growth than the norm in many parts of the world remains a distinct possibility. Central bankers continue to remain open to creating further stimulus as embattled economies navigate their way through the current economic climate. Primary strategies to spur recovery in the global economy have included buying short-dated bonds in Europe, lowering borrowing costs and injecting further liquidity into the US. Events in South Africa have mirrored those across the rest of the global economy. Weak economic activity has continued to focus policymakers' attention on ways to boost growth. Against a backdrop of weak demand and no immediate signs of any broad-based inflation threat locally or abroad, the monetary policy committee provided further stimulus by dropping the repo rate to 5% in July 2012. The recent mining labour unrest coupled with a downgrade by rating agency Moody's highlights the deterioration in domestic fundamentals and concerns around the government's ability to deliver on its mandate. The outlook for the local economy remains uninspiring and growth projections for this year and 2013 are continually being revised downwards. This backdrop provided a favourable environment for local listed property counters because weak growth is likely to result in lower inflation and interest rates (and hence bond yields) for longer. The domestic real estate sector therefore enjoyed another strong quarter, returning 11% for the 3 months to end September 2012. For the year to date, the sector has delivered an impressive 32.2%. Equities came in second over the quarter, gaining 7.3%. Bonds followed with a return of 5% and cash added a marginal 1.4% and 4.3% for the year to date.
Portfolio activity The third quarter is traditionally a busy reporting period for the listed property sector with heavyweights such as Growthpoint, Hyprop and Capital reporting results. Other counters that also reported results included Hospitality, Resilient, SA Corporate, Fortress and Vunani, as well as Synergy that declared its first set of results. Across the sector, results were in line with our expectations, except for Hyprop and SA Corporate that both reported better results than we expected. They delivered distribution growth of 9% and 5.7% respectively. Resilient and Fortress led in terms of distribution growth, both delivering 10%, whilst the sector laggard was Emira which delivered -2.5%. The benefit of portfolio scale was a theme that was evident during the results season. Large caps like Growthpoint, Capital and Hyprop were all able to benefit from their size and economies of scale to reduce costs, with the balance of funds still experiencing the negative impact of higher utility costs. The cost of borrowing continues to decline with the repo rate at an all-time low. Management teams have taken advantage of the opportunity to secure cheaper funding, which should make capital investment more attractive going forward. We increased our position in Fountainhead in a bid to reduce our underweight position in the stock and take advantage of its pricing relative to Redefine, in light of the potential corporate action between the two counters. Further sales in Emira were enacted, a counter where we continue to have concerns about the portfolio's substantial, struggling B-grade office exposure. Units in Sycom were also sold into relative strength. Contributors to the listed property sector's stellar performance over the period were led by Investec Property which gained 29.5%, followed by Synergy A (+23.3%), Synergy B (+20.4%), Hospitality A (+25.3%), Dipula B (+19.1%) and Nepi (+17.6%). The only counter to produce a negative return over the period was Hospitality B, delivering -11.8%.
Portfolio positioning Local policymakers remain open to further monetary easing in light of persistently weak global growth expectations. Countering this tailwind for the real estate sector is the uncertainty about continuing industrial action and the lead up to the ruling party's December conference. This could place pressure on the currency and bond yields. Despite a healthy sector forward yield of 7% and distribution growth of between 6-7% projected for the year ahead, sector returns in the coming 12 months are likely to be far more muted than the exceptional levels we have already witnessed this year. We are of the view that property fundamentals remain stable and that in a weak growth environment the defensive nature of income from property should continue to support the sector and the portfolio.