Market review

Investor optimism permeated markets and supported most risk assets in May as the gradual easing of COVID-19 related restrictions in a number of countries gave rise to hopes of an impending return to normality in the global economy.

After posting solid gains of +7.3% in April, global property securities took a pause in May as the FTSE EPRA Nareit Developed Index (in EUR terms) returned -1.3%, trailing the MSCI World Index, which returned +3.2% (in EUR terms). All following index returns are expressed in local currency terms.

In North America, US REITs were flat in May (-0.2%), trailing the S&P 500 Index, which gained a solid +4.8%. US REITs are now down -23% this year to date, while US equities are down a relatively meagre -5%. The COVID-19 situation in the US has recently improved, as the curve of new infections has ‘flattened’. Virus containment measures are now being relaxed, which is seeing the economy begin to re-open, while massive fiscal and monetary stimulus continues to offer a level of support.

As businesses started to progressively re-open across the country in May, the US economy surprisingly added 2.5 million job in May, massively exceeding consensus expectations of 7.5 million of job losses for the month. This reflects a sharper return back to work than anticipated and highlights the benefits of the Fed’s payroll protection lending program, which required employers to maintain staffing levels. The job gains saw the unemployment rate decline from a post-Great Depression high of 14.7% in April to 13.3% in May.

The US ISM Services PMI* rose 3.6 points to 45.4 in May, although the Index remains below 50, indicating the services sector is still in contraction. Timely and aggressive action by the Federal Reserve has kept financial conditions much more accommodative than in past down cycles, including the Great Recession of 2008 and the mild 2001 downturn. The Fed’s balance sheet is set to increase from $4 trillion to $9 trillion.

Meanwhile, Canadian REITs fell -2.1% in May after gaining +6.5% in April. The group trailed the broader Canadian equity market by 5.1% as it struggled to find its footing after a couple of months of heightened volatility amid COVID-19. Among the Canadian REIT sub-sectors, industrial and multi-family assets performed best, while office and diversified REITs lagged the most.

In Europe, REITs posted a modest gain of +1.6% during May. The best performing region was Germany (+9.4%), followed by Sweden (+2.1%) and the UK (+0.3%), while France (-5.5%) was the worst performing market. The reporting season continued during the month, which saw several large UK REITs display resilience in their London office portfolios, though there were significant falls for retail portfolios.

Rent collections remain significantly depressed in the retail sector, at around 40%, and there are expectations for the next collection date in June to fare even worse. We have now witnessed most retail shops re-opening across of Continental Europe, with footfall conversion rates and basket sizes reportedly being higher than expected. There are also plans in place for restaurants, cinemas and hotels to start reopening from the beginning of July.

The ECB1 and BoE2 left official policy rates on hold in May; however, the ECB increased the size of the Pandemic Emergency Purchase Programme by another €600 billion in June. An update of GDP expectations will also be provided in June. President Lagarde has already ruled out a ‘V-shaped’ recovery and economic output is not expected to return to pre-COVID-19 levels until 2022.

In Asia, returns were mixed in May. The Japanese listed property market led the charge as it returned +5.8%, while JREITs specifically (excluding developers) were up +7.9%. Japanese names surged as the country’s COVID-19 infections moderated in the latter part of the month, which saw the State of Emergency lifted progressively across Japan. This aided the recovery in some of the higher beta JREIT shares, particularly those in the hardest hit retail and hotel sectors, although office and diversified names also benefitted.

On the other hand, Hong Kong listed property fell dramatically (-13.9%) after Beijing imposed controversial national security laws in Hong Kong, spurring widespread demonstrations and raising fears of further social unrest in the months to come. This prompted the US to claim that Hong Kong is no longer autonomous from China, inducing concerns that the territory may lose its special trade status with the US.

The Hong Kong retail sector continues to be challenged by a combination of COVID-19 and the unrest, with retail sales falling -42% YoY in March and -36% YoY in April. The broader economy contracted -8.9% YoY in the first quarter of 2020 and unemployment rose from 3.1% to 5.2%, the worst level in more than 15 years. In May, the economy started to progressively re-open, including malls and schools; however, this positive news flow was more than offset by the negative sentiment permeating the region.

In Australia, the ASX200 A-REIT Index continued to bounce back in May, returning +7.0% for the month and outperforming local equities by 2.6%. Industrial (+16.9%) and diversified A-REITs (+8.3%) led the charge, while office landlords (-1.3%) posted the weakest returns.

A-REITs have now gained +42% since their 23 March low, driven in part by improving sentiment as Australia has effectively contained the spread of COVID-19, with remarkably less than 500 active cases of the virus at month end. This has enabled policy makers to gradually re-open the domestic economy quicker than anticipated. The Australian economy shrank by -0.3% in the first quarter of 2020, faring relatively well compared to other developed nations.

Fund performance

The Fund returned -1.0% in May3, 31 basis points above its benchmark index, the FTSE EPRA Nareit Developed Index.

Annual Performance (% in EUR) to 31 May 2020

These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than the share class currency, the return may increase or decrease as a result of currency fluctuations.

Performance figures have been calculated since the launch date. Performance data is calculated on a net basis by deducting fees incurred at fund level (e.g. the management and administration fee) and other costs charged to the fund (e.g. transaction and custody costs), save that it does not take account of initial charges or switching fees (if any). Income reinvested is included on a net of tax basis. Source: Lipper IM / First State Investments (UK) Limited.

*The benchmark changed from UBS Global Real Estate Investors on 20/05/2013

Our exposure to US single-family housing contributed positively to performance during the month. The sector has been largely insulated from the COVID-19 pandemic, which has seen rent collections have remain above 90% in the US. This has been underpinned by the US Government’s extensive fiscal stimulus measures. Moreover, single-family landlords are starting to benefit from increased demand as lock-down measures are being eased and consumers are increasingly looking to move from high-density cities and apartment living to live in detached housing in the suburbs.

Active exposures to logistical warehousing in the US, Japan and the UK also added value. Investors continue to favour the sector, as it is expected to benefit from an acceleration of e-commerce related demand. Moreover, the fundamentals of industrial assets are expected to be supported by further investment into distribution supply chains, particularly after the panic buying earlier this year saw a number of retailers and etailers unable to meet customer demand.

Our underweight exposure to shopping malls globally also continued to benefit the Fund’s relative performance. The sector underperformed as it continues to be plagued by COVID-19 related headwinds. Rent collections have been severely depressed due to COVID-19 related lock-downs, while news flow surrounding retailer bankruptcies and store closures also weighed on the group.

Further tenant insolvencies are likely in the near-term due to the challenges of the pandemic, and the longer-term structural shifts towards e-commerce, which have seemingly been fast-tracked in recent months, are expected to see a longer term deterioration of fundamentals across the sector.

The Fund’s exposure to office buildings across North America, Europe and Australia detracted from performance. The sector underperformed amid mounting concerns regarding how expected shifts towards flexible work arrangements could weaken future demand for office space over the medium to long term.

Market outlook and Fund positioning

The Fund has exposure to high quality assets in high barrier to entry urban locations in the world’s most bustling cities.

The US economy is starting to progressively re-open and recover after the sharpest contraction since WW2, which has seen unemployment soar to record levels. The easing of restrictions, coupled with the unprecedented level of monetary and fiscal stimulus, will drive a recovery in the second half of 2020 and 2021, but the timing and shape of this recovery remains unclear.

US real estate fundamentals are deteriorating across many sectors, given lower rents, rent deferrals/abatements, increased vacancies, rising bankruptcies and higher levels of bad debt. However, REIT balance sheets entered this crisis in good shape, with Debt/GAV4 at ~32% and little near term refinancing. US REIT earnings are now expected to decline -4% in 2020, down significantly from the initial expectations of +5-6% growth at the start of the year. Corporate profits are expected to decline -18% this year, representing a huge reversal from the +9% growth anticipated at the start of the year.

Our US exposures are concentrated on sectors which should hold up relatively well in a recession, including single family rentals and apartments, logistical warehouses, data centres and selective office and healthcare exposures. We have also added high quality supermarket anchored shopping centres and senior housing exposures, which we believe should benefit from the economic recovery, given the material discounts these names trade at following significant COVID-19 selling. We remain cautious on the lodging, mall, net lease, and office sectors given challenging near-term outlooks.

In Canada, we view REITs as relatively attractive in the current context of the COVID-19 crisis. While we expect growth in the Canadian economy to slow down dramatically (and in fact contract on a short-term basis), we believe some of the decline will be tempered by the fact that the economy was in a solid position at the start of the crisis. At the virus’ onset in April, Canada’s overall economic base, labour markets, housing markets and capital markets were all in very healthy shape. While we expect a severe economic contraction in the near-term, with consensus expectations being for a 8.2% decline in GDP in the second quarter, we believe the large amounts of fiscal and monetary stimulus will support a solid, steady rebound. Our main exposures in Canada are to the relatively defensive apartment and office sectors.

In Europe, the results reported in May were generally solid, although the outlook continues to be very uncertain. Rent collections improved marginally from April to May, but remain worryingly low for the retail, hotels and leisure sectors. We expect third quarter rent collections to be even more challenged, given most companies have been closed for a good portion of April and May.

Nevertheless, shops started to re-open across Europe in May, while Hotels and Leisure expected to reopen from July. First indications of footfall in shoppingcentres has been better than expected, with levels already at 80% of the prior year. Against this backdrop, in Europe we have minimal exposure to the most heavily impacted retail and hospitality sectors, and we have also reduced our student accommodation exposure to zero given the near-term headwinds. We remain positioned in the relatively insulated industrial and residential sectors, as well as offices in the main European capitals.

In Japan, the most heavily impacted sectors continue to be retail and hotels, which have required widespread rent discounts and deferrals. We continue to have a negative outlook for retail and hotel landlords and, as such, continue to have zero exposure to both sub-sectors. Conversely, rent collections have remained largely unaffected for office, residential and logistics landlords.

Against this backdrop, we have retained our existing positions in logistics, office and residential JREITs by adding well positioned, attractively priced diversified JREIT exposure to the portfolio. We continue to have no exposure to Japanese developers given ongoing concerns around a weak transactional environment for asset sales and the deteriorating letting backdrop for assets held on balance sheets.

In Hong Kong, lock-downs have been eased gradually from the second week of May, but we continue to expect a slow and gradual recovery as international borders remain closed. The Hong Kong economy fared materially worse than expected in the first quarter, as GDP slumped -8.9% YoY, while government projections were downgraded to between -4% to -7% for 2020. The domestic economy is now in deep recession, with Q1 marking the 3rd consecutive quarter of contraction and representing the biggest quarterly decline on record since data became available in 1974.

The uncertainty in the region is unlikely to abate any time soon, following China’s latest National Security Laws. We expect domestic sentiment and consumption to remain fragile and for unemployment rates to rise further. Moreover, in real estate markets, negative rental growth and higher vacancies are likely to persist across all property sectors in 2020 and likely beyond.

Accordingly, we continue to be underweight to the region overall. We retain selective exposures to property names with low leverage, strong balance sheets and robust cash flow growth. We continue to avoid pureplay retail exposures in Hong Kong, which are facing significant declines in cash flow and earnings for the first half of 2020 due to tenancy rental rebates, while maintaining a selective exposure to premium malls in China and Hong Kong mass residential.

In Singapore, we continue to have no exposure. As expected, the majority of SREITs released bearish outlooks this month, with many of them cutting dividends to reserve cash amid the COVID-19 uncertainty. As Singapore has experienced a second wave of infections, the country will stay in the strictest level of lock-down until the end of June at the earliest. This bodes very poorly for property landlords, which will bear the burden of rental rebates and deferments. We continue to believe that SREIT valuations are relatively unappealing compared to global peers.

In Australia, the portfolio remains positioned primarily with diversified exposure to the logistics, office and manufactured homes sectors. We also retain a select exposure to an attractively priced Australian mall landlord that was materially oversold after a COVID-19 induced sell off. Combined, we believe these sectors offer attractive relative valuations and a relatively high degree of immunity from the challenging macro operating environment.

* The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers’ Index (PMI) (also known as the ISM Services PMI)

1 European Central Bank

2 Bank of England

3 Performance is based on OEIC B share class, net of fees, expressed in EUR.

4 Debt/Gross Asset Value

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