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Volatility returned to investment markets over the past year as growth accelerated and central banks, especially the US Federal Reserve (Fed), started to remove excess liquidity by raising interest rates and reversing quantitative easing.
As a defensive, income focused equity strategy, the BetaShares Legg Mason Real Income Fund (managed fund) (RINC) is positioned to perform relatively well in such environments and that is exactly what the Fund has done to date.
RINC generated a total return of 19.55% (net of fees) over the year to 29 March 2019, significantly outperforming the broader share market (S&P/ASX 200 Accumulation Index: 12.06%).
*13 February 2018. Past performance is not indicative of future results.
RINC’s investment strategy
Low risk, low beta, low volatility stocks tend to perform well in times of uncertainty and market uncertainty has clearly increased. RINC’s resilience over the year is related to the types of stocks in which it invests.
RINC holds a portfolio of listed companies that own ‘hard’ physical assets, like property, utilities and infrastructure (e.g. A-REITs, airports, toll roads, electricity and gas grids).
Real asset companies like these are an integral part of everyday life and are often monopolistic in nature. Their demand profile is therefore relatively inelastic and not pegged to the business cycle, hence these companies have more predictable free cash flow and dividends. The typically long-term nature of their cash flows (underpinned by long term contracts and favourable regulatory structures) also offers a level of protection during market downturns, as well as upside growth potential from population growth. This means real asset companies typically have a low beta versus the broader equity market and can provide a low-volatility regular income stream.
Due to their strong market positions, and the growing demand driven by population growth, real asset companies often have the ability to raise prices, in some cases above inflation, irrespective of the business cycle. In other words, real assets generally have the ability to protect future income from inflation. This makes them relatively defensive investments.
Very few investment funds in Australia offer this combination of assets.
Advantages over A-REITS
We consider RINC to be a much better solution to real assets than a traditional standalone investment in the A-REIT Index. Compared to owning just A-REITs, RINC has several advantages:
- Lower concentration risk – RINC’s investment universe is more diversified as it includes infrastructure and utilities, so it avoids the concentration issues associated with the A-REIT Index.
- Lower single stock concentration – RINC is actively managed and seeks to deliver high, sustainable and growing income. The portfolio managers focus on building a diversified portfolio that is not overly exposed to any one company or thematic. For example, Scentre Group has a 19% weight in the A-REIT Index but its exposure in RINC is only 4.9%1.
RINC also has a 9% maximum stock limit at time of purchase, ensuring that it constantly remains well diversified across individual stocks and real asset sub-sectors.
The effect of bond yields on RINC
RINC’s underlying investments include listed real assets such as A-REITs, utilities and infrastructure, and their pricing is inversely influenced by the prevailing bond yield. If bond yields rise, the price that the market is prepared to pay for real assets may come under downward pressure because a higher bond yield means a higher discount rate for a future income stream, reducing the market price of real asset companies. The opposite is also true – as bond yields fall, the share prices of real asset companies tend to perform well as it implies a lower discount rate for future income streams. This is what happened in the second half of the year, underpinning Fund performance.
Australian 10-year bond yield
Source: RBA as at 28 February 2018.
Real asset market outlook
For the real asset sector, the outlook is robust from an earnings perspective and we believe this should support an attractive dividend yield for the stocks in RINC’s portfolio:
- Retail sales, despite a slower December 2018 quarter, look to have bottomed late in 2018, signalling a better outlook for retail real estate investment trusts (REITs). With a better wage environment and healthy employment levels, this trend should continue.
- Office demand remains strong, in-line with robust GDP. Office capitalisation rates look to have bottomed for this cycle, but there is no pressure yet for these to start rising. We expect more affordable suburban markets to mirror the strength in the CBDs.
- Residential credit tightening is still affecting the forward order books of developers, but this seems to be more about future volumes than settlements of past sales. A reduction in existing dwelling prices is playing out as expected, and we are seeing some pressure on both selling prices for new product developed by residential developers and retirement-village operator rents. However, population growth is ultimately supportive, especially in Victoria and Queensland where affordability is better.
- In utility markets, policy uncertainty is seeing investment capital sit on the sidelines but Renewable investment impacts are still to play out in energy markets, as some older, less efficient coal-fired electricity generation exits the market over time. Asset base growth for gas and electricity grids and networks – pipes, distribution and transmission – will be slower, but volumes continue to be bolstered by material population growth.
- For the infrastructure sector, strong volume growth in toll-road traffic, airport passengers and child-care patronage is expected with these growth rates maturing in outer years. Toll-road regime optimisation remains an important driver, especially as truck tolls rebase upwards.
Foreign capital is still eyeing Australia’s attractive internal rate of return (IRR) for yield and growth, with supportive appeal from our high levels of disclosure and transparency in real asset markets.
We remain positive on the prospects for high-quality real assets, with conservative balance sheets and cash flows and distributions. On a forward-looking basis, RINC’s portfolio is forecast to provide a dividend yield of 6.0% (grossed up for franking credits) over the next 12 months to February 20202.
The key drivers of this income stream – population growth and real assets’ ability to increase pricing in line with inflation (think utility company and toll road increases) – remain strong.
We believe RINC is uniquely positioned in an asset class that can provide a growing and sustainable income stream. Many real assets such as shopping centres, ports, toll roads and airports are considered essential assets for the economy and are well positioned to grow their business as the Australian population increases. This provides a long-term income opportunity that few other asset classes can match. Some of the top holdings in the Fund include Transurban Group, Stockland, Vicinity Centres, Scentre Group and AGL Energy3.
Overall, we think the recent market volatility is providing tactical opportunities to invest in an attractive asset class, with solid fundamental growth leveraged to Australia’s population growth. While the uncertainty over the macro environment and the direction of long bond yields could create further market volatility in coming months, we remain positive on the prospects for RINC’s underlying share holdings, which tend to have conservative balance sheets and sustainable distributions.
RINC is managed by wholly owned Legg Mason investment affiliate, Martin Currie Australia. Martin Currie is a global active equity specialist, crafting high-conviction portfolios, which aim to deliver attractive and consistent risk-adjusted returns for clients.
The Fund can be bought and sold like any share using the ASX code: RINC.
1As at 28 February 2018. The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
2 Yield forecast is calculated using the weighted average of broker consensus forecasts for each portfolio holding and research conducted by Legg Mason Australia, and excludes the Fund’s fees and costs. Franking credit benefit assumes a zero tax rate. It is not to be interpreted as the offset achieved by unitholders during this period. 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. Not all investors will be able to benefit from the full value of franking credits.
3As at 28 February 2019. The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
Past performance is not an indicator of future performance. This article has been prepared by Legg Mason Asset Management Australia Ltd (ABN 76 004 835 849 AFSL 240827) (Legg Mason Australia). BetaShares Capital Ltd (ABN 78 139 566 868 AFSL 341181) (BetaShares) is the issuer and responsible entity of the BetaShares Legg Mason Real Income Fund (managed fund) (ARSN 621 862 619) (Fund). BetaShares has appointed Legg Mason Australia as investment manager for the Fund. Legg Mason Australia is part of the Global Legg Mason Inc. group. Martin Currie Australia, a division within Legg Mason Australia, provides the investment management services for the Fund. Any reference to ‘Legg Mason Australia’ or ‘Martin Currie Australia’ is a reference to Legg Mason Asset Management Australia Limited. Before making an investment decision you should read the Product Disclosure Statement (PDS) for the Fund carefully and consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting BetaShares on 1300 487 577 or Legg Mason Australia on 1800 679 541 or at www.betashares.com.au or www.leggmason.com.au. This information does not take into account the investment objectives, financial objectives or particular needs of any particular person. Neither BetaShares, Legg Mason Australia, nor any of their related parties guarantees any performance or the return of capital invested. Past performance is not necessarily indicative of future performance. Investments are subject to risks, including, but not limited to, possible delays in payments and loss of income or capital invested.