Exploring the benefits of active management in listed real estate during 2020
Fund Manager - Real Estate Sydney, Australia
It has been seven months since the World Health Organization declared COVID-19 a world-wide pandemic. During this time, we have seen significant disruption to the way we live, work, educate and entertain ourselves. The spread of the virus and its containment measures has had a significant impact on the operations of many real estate assets. Hotels, shopping centres, gaming and senior housing have been severely impacted, being assets that usually thrive on being a place for people to congregate.
Investors’ portfolios have been impacted across all asset classes, however, with real estate one of the hardest hit and one of the most visually impacted, it is worth reflecting on the benefits an active management approach has had on your real estate portfolio during this period.
On-the-ground insights
With no playbook available to us about how COVID-19 would develop, having portfolio managers on the ground in locations around the globe provided us with the capability to identify risk and opportunity more quickly. These specialists were able to spot any unusual activity and, in the case of COVID-19, forewarn the broader team of an event that was to rapidly sweep through the rest of the world.
As the pandemic has evolved, different geographies have experienced varied impacts and having team members in these locations has allowed for real-time information sharing. Active management allows for a tilt between geographies, depending on how well they have managed the crisis, what stage they are in terms of containment, and what impact containment measures are having. Early in the crisis it was appropriate to move to an underweight position in the Hong Kong market as the virus moved offshore from China, and we have been able to adjust this holding appropriately as that market moves through the various stages of virus containment.
Active allocations
Active management allowed us to move to an underweight position in the sectors with the greatest risk early in the crisis, helping to position the portfolio defensively and mitigate short-term downside risk.
The retail sector which has faced structural challenges over the last few years as a result of the growth in ecommerce, particularly in the US and Europe, has become one of the hardest hit sectors due to COVID-19 containment measures. Listed real estate indices (particularly the S&P/ASX 200 AREIT Index in Australia) have a disproportionately large exposure to this sector, with the composition of any index being backward looking and reflecting the historical outperformance of shopping centres.
An active management approach allowed for an underweight starting position to this underperforming sector, which has now been further reduced. We were also able to swiftly reverse our growing hotel exposure in response to COVID-19 impacts and be selective about our healthcare exposures, particularly towards the aged-care sector.
We are carefully monitoring these sectors as we move through the different waves of COVID-19 and assess how the risks have been factored into market valuations. Active management can allow us to capitalise on any mispricing opportunities and attractive capital raisings that may arise.
Portfolio construction
An active management approach intentionally allows for the construction of a portfolio that has every component of the portfolio included to complement each other, even as adjustments to allocations are being made. This reduces the potential of being over or under exposed to allocations that could negatively impact performance or unnecessarily increase risk.
This can also allow for the construction of a portfolio that targets the unique objectives of its investors including Environmental, Social and Governance (ESG) objectives. Active management enables the screening of companies on specific ESG criteria and can help initiate positive change and build on standards for sustainability. The active screening of investments for ESG credentials, quality, value or risk, can allow a manager to remain true to label, even throughout major moments of market volatility.
Risk management
When markets are fast moving, it is necessary to be able to adjust our investment approach. This is especially important when markets are falling, and risk needs to be taken off the table. Whilst real estate is a long-term investment and we need to look through short-term disruptions, in moments of significant market upheaval we believe it is important to mitigate exposure to short-term risks, while not losing sight of long-term thematics. With extreme market volatility, a switch to a more defensively positioned portfolio helped us to reduce downside risk quickly through this pandemic period.
A manager also needs to be able to quickly reassess risk, and their appetite for it, adjusting for new circumstances and market volatility. A previously acceptable level of leverage may now not be as tolerable. An exposure to short-term lease expiry or vacancy, or substantive debt refinance may now be considered too risky. An active management approach requires a good understanding of the quality of the underlying assets and what exposure the tenant base has to industries that may have been negatively impacted by the effects of the pandemic.
Where are the winners?
Knowing that there is a ‘flight to quality’ response in periods of market downturn, our focus has been on allocating to what we consider as more defensive positions in higher quality investments. In terms of what constitutes quality for us, we look for investments with:
- Secure and sustainable cashflow;
- Balance sheet strength and liquidity; and
- A sustainable business model in an evolving COVID-19 world.
An active management approach caters for a wider investible universe beyond the past winners that comprised an index. This is beneficial when some of the largest and biggest sectors are being hit by pandemic impacts and forecast future winners are outside an index. It can also help facilitate a more diversified portfolio, which can mitigate risk. A sector that has exhibited these characteristics and has not only been a growth sector over recent years but is also a beneficiary of COVID-19 containment measures, is data centres1.
The generation of data continues to grow exponentially and shows no sign of slowing, in fact accelerating during the pandemic due to the increase use of streaming, video conferencing, remote working and an increased shift to a digital world2. This is being recognised by equity investors with the Zoom share price skyrocketing over 40% the day after reporting its second quarter earnings results, which showed that new customers’ subscriptions delivered 81% of revenue growth. Zoom’s share price has risen by over 370% for the year to date (to early September) to be one of the best performing companies in 2020.
Real estate investors can participate in the growth of the use of data by investing in data centres. Whilst pricing of the sector is reflective of investors’ appreciation of current growth, we believe there is still value due to the strong longer-term fundamentals. We anticipate that growth will continue beyond the pandemic due to the following key reasons:
The collection and use of data
Knowing the customer and personalisation of service are huge competitor advantages to an organisation and as they expand their data collection capabilities, storage requirements grow. Furthermore, the computing power needed to sort and analyse huge swathes of data requires appropriate infrastructure, housed in a data centre.
Cloud-based computing
More and more companies are moving to cloud-based computing systems, which has helped facilitate their workforce working remotely. Multi-tenanted data centres are integral when multi-cloud-based approaches are applied, helping to reduce latency.
Internet of Things and the rollout of 5G
Data centre infrastructure is key to delivery of strategy for companies adopting Internet of Things technology and facilitating a 5G world. Huge growth areas include autonomous vehicles, advances in healthcare and manufacturing will further drive demand for huge quantities of data.
Ecommerce
The growth in ecommerce can be partly attributable to the more than 3.5 billion smartphone users worldwide accounting for 52.6% of global web traffic3 with more than half (51%) of internet users using their mobile phones to purchase products online4. The speed of being able to deliver information is now a necessity, as many as half of consumers abandon purchases as soon as there is latency as little as 3 seconds in the loading of a website5. Data centres in well-located areas are key to be able to deliver on this service for businesses.
How can we invest in this growth sector?
One of the world’s largest and best performing data centre providers, Equinix, is invested in 214 data centres in 56 metros, across 26 countries and five continents. We consider Equinix to be well capitalised, with access to high quality assets, experienced and trusted management, and low leverage – satisfying all our key elements for defensive investing at this point in the cycle. Having limited near-term lease expiries (0.4 million square feet for renewal prior to 2023) and a weighted-average lease maturity of greater than 18 years, including extensions, further de-risks this investment. Furthermore, Equinix provides exposure to a sector that is not only benefiting from the pandemic but also shows long-term growth prospects, being positioned to respond to their customers’ digital transformation.
Equinix share price increased by 20.3% in the first six months of 20206 in sharp contrast to broader market declines. The June quarter represented the company’s 70th consecutive quarter of revenue growth, and was one of the strongest quarters in the company’s history7 being a beneficiary of the conditions imposed by COVID-19 containment measures. Furthermore, data centres were identified by governments around the world as providing essential services and remained operational throughout the pandemic.
Whilst classified as a REIT, Equinix does not meet the criteria to be included in the FTSE EPRA/NAREIT Developed Index, a global real estate index, and in fact, the entire data centre sector is not included in the index at all in Australia. Access to unlisted real estate exposure to data centres is difficult to achieve, with transactions to date being hotly contested and highly competitive. Therefore, access to this high performing sector is generally only accessible to a listed real estate investment by an active manager willing to allocate beyond the indices.
Conclusion
The benefits of active management have been highlighted during the COVID-19 pandemic period, with the ability to shift allocations away from sectors facing the highest exposure to its impacts. In particular, the benefits are seen in portfolio construction and risk management, with the ability to defensively position and reassess risks early in the crises and ongoing through the management of its impacts. The active manager can also be opportunistic, allocating to sectors forecast to benefit from the new state of play we now operate in, whilst also being mindful of longer-term thematics.
The AMP Capital Core Property Fund combines actively managed Australasian and US unlisted real estate and Australasian and global listed real estate with the aim of generating a better risk/return profile over the long term.
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1 UBS Research, Equinix, DLR, AMP Capital
2 UBS Research, Equinix, DLR, AMP Capital
3 Statista, 2019
4 Datareportal, 2020
5 Akamai – 2018 State of Online Retail Performance
6 S&P Global Market Intelligence
7 Equinix Second Quarter 2020 Results
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Claire Talbot, Fund ManagerIMPORTANT NOTE: Investors should consider the Product Disclosure Statement (PDS) available from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) (AMP Capital) for the AMP Capital Core Property Fund ("the Fund") before making any decision regarding the Fund. The Trust Company (RE Services) Limited (ABN 45 003 278 831, AFSL 235150), a wholly owned subsidiary of The Trust Company Limited (ABN 59 004 027 749), is the responsible entity of the Fund and the issuer of units in the Fund. The PDS contains important information about investing in the Fund and it’s important investors read the PDS before making a decision about whether to acquire, continue to hold or dispose of units in the Fund. None of the responsible entity, AMP Capital or any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this document. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this document, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.