Reading time: 3 minutes
As coach of the Australian rugby team, you pick your biggest and toughest players heading into the World Cup. Fortunately, the current crop are some of the best Australia has seen. That said, they are a big bunch of lads, so will require regular interchanges to make the most of their bulldozing abilities throughout the matches. The team relies heavily on three or four highly-skilled ball players to create attacking and point-scoring plays.
As you make your way on to the field for the pre-match warm-up, the World Cup Association announces a surprise change to the rules – no interchanges will be allowed for the entire game, and for every other game of the tournament.
The equation has changed. You’ll be forced to send out a team of bulky players with poor ball skills, that will likely run out of steam before half time, without being able to sub them on and off. Your all-in strategy has come undone – bigger has not been better, and the risks of putting all your faith in a couple of key players have been realised.
The above situation is essentially the scenario we witnessed with many passive exposures to Australian property earlier this year. It highlighted the risks faced by investors who take an index-tracking approach to their property allocation, and who consequently may have a heavy exposure to a small number of stocks.
A quick look at the top holdings of an ETF that tracks the S&P/ASX 300 A-REIT Index shows that, as of 31 July 2020:
- the top holding accounted for ~26% of the portfolio
- the top 3 holdings accounted for ~45% of the portfolio
- the top 6 holdings accounted for ~68% of the portfolio
The concentration risk of a portfolio such as this is high. In the first quarter of this year, listed property stocks were hit hard, and the S&P/ASX 300 A-REIT Index fell by 48.8% between 21 February and 23 March1.
Australian listed property is, in my view, one of the rare cases where there is a strong argument for active rather than passive exposures, in part because active managers can employ strategies to reduce single stock risk and mitigate certain sector risks. As a result, in the first quarter of 2020, 62% of active A-REIT managers were able to outperform their benchmarks2, whereas the majority of active managers in general Australian equity, international equity, and fixed income underperformed their benchmarks over the quarter.
An alternative way of getting property exposure
We believe there is a strong argument for getting your property exposure as part of a more diversified investment in ‘hard’ physical assets.
The BetaShares Legg Mason Real Income Fund – Managed Fund (ASX: RINC) provides exposure to a portfolio of companies that own physical assets such as property, utilities and infrastructure, and aims for a more diversified exposure of between 20-40 holdings, with the largest position currently being only ~7% of the fund.
The diagram below compares the weightings of the top five stocks in RINC’s portfolio with the top five stocks in the S&P/ASX 300 A-REIT Index (as of 30 June 2020).
Source: Martin Currie Australia and BetaShares; as at 30 June 2020. The information provided should not be considered a recommendation to buy or sell any particular security. It should not be assumed that any of the securities were, or will prove to be, profitable.
RINC’s blended property/infrastructure/utilities portfolio allows for a broader exposure to real assets, diversifying your exposure beyond pure property plays.
The fund is actively managed by leading Fund Manager, Martin Currie (part of the Franklin Templeton Group). The value of an actively managed approach has been illustrated in the move out of softer assets such as airports and shopping centres and into defensive assets such as gas pipelines and utilities (27% of RINC’s portfolio3) amidst the COVID-19 crisis.
Four of the S&P/ASX 300 A-REIT Index’s top five holdings are exposed to commercial office real estate. With more than two-thirds of workers saying they are more productive at home4, COVID-19 has thrown into question whether remote work will become a permanent fixture for some firms. A dramatic fall in demand for commercial property could potentially undermine one of the index’s core exposures (24% held in office real estate).
In comparison, RINC has a 17% exposure to commercial office real estate5.
As RINC commenced in February 2018, the unlisted Legg Mason Martin Currie Real Income Fund, which uses the same strategy as RINC, is used to illustrate long-term performance in the chart below. The unlisted fund has outperformed the S&P/ASX 300 A-REIT Index by 2.1% p.a. from inception in 2010 to 31 August 2020, including by 6% in March 2020.
Source: Morningstar Direct. Past performance is not indicative of future performance.
The Legg Mason Martin Currie Real Income Fund has also shown lower volatility (13.2% p.a.) than the S&P/ASX 300 A-REIT Index (17.0% p.a.) since inception in 2010, giving investors a smoother ride, and a higher risk-adjusted return (Sharpe ratio of 0.79 vs. 0.54).
What’s more, in a world where income is increasingly hard to come by, RINC offers attractive yield potential for investors. As at 31 August 2020, the forecast yield of the portfolio was ~6% p.a6.
To learn more, please refer to the Fund page.
1. Source: www.spglobal.com
2. Source: SPIVA Report Australia, Q1 2020.
3. As at 30 June 2020.
4. Source: https://www.afr.com/work-and-careers/careers/it-s-more-productive-to-work-from-home-20200401-p54fwc
5. As at 30 June 2020.
6. Yield forecast is calculated using the weighted average of broker consensus forecasts of each portfolio holding and research conducted by Legg Mason Australia, and excludes the Fund’s fees and costs. Actual yield may differ due to various factors, including changes in the prices of the underlying securities and the number of units on issue. Neither the yield forecast nor past performance is a guarantee of future results.