By Roeloff Horne | Director and Head of Portfolio Management (SA)
At MitonOptimal, we subscribe to a dynamic strategic asset allocation process and debate the real/absolute return prospects for each investable asset class in our regulated universe. Each member of the team makes a contribution per asset class which is followed by a debate and a team decision. The results are used to run our optimization process for the ZAR/USD/GBP portfolios. Part of the process is to gather views from our underlying managers to complement our own process and debate. To illustrate our challenges, I will share some of my preparation for medium term (4-5 years) global listed real estate projections.
We approach the process by debating the fundamentals of each asset class within the business cycle, understanding the current yield and earnings projections and looking to the past for guidance on performance in all business cycles.
Firstly, we will look at the projections of STANLIB – a large South African Asset Manager. Their total return expectations are divided into a bull, bear and base case scenario’s where they make assumptions on the US 10-year bond yield, the expected exit yield and expected earnings growth over 1- and 4-year periods.
Total return expectations – Global Property ($)
|1 Year||Bull Case||Base Case||Bear Case|
|Total Return (Income and Capital)||20.20%||13.46%||6.12%|
|Assumption 1: US 10 Year Bond Yield (Current 2.71%)||2.50%||3.00%||3.50%|
|Assumption 2: Exit Yield (Current 4.44%)||4.04%||4.29%||4.60%|
|Assumption 3: Earnings Growth||5.00%||5.00%||5.00%|
|4 Years (Lower for Longer Interest Rates)||Bull Case||Base Case||Bear Case|
|Total Return (Income and Capital)||8.88%||7.60%||6.40%|
|Assumption 1: US 10 Year Bond Yield (Current 2.71%)||3.00%||3.50%||4.00%|
|Assumption 2: Exit Yield (Current 4.44%)||4.59%||4.84%||5.09%|
|Assumption 3: Average Earnings Growth||5.00%||5.00%||5.00%|
At first sight, their base case scenario of 13.46% over a one-year period appears very bullish. However, when one considers a base ‘date’-in this case, early January 2019 -it is fair to reason that after a poor 2018, where US REITs returned -4.55% and non-US REITs returned -6.7%, a 13% absolute return in the following 12 months is not inconceivable. When one considers the January 2019 performance, nearly 10%, it feels as if most of the returns for the year are in the bag! However, using 1 January 2018 as your base, one immediately realises that this was merely a recovery rally from a low base (US REITs up 5.8% and non-US REITs up 2.1% over 13 months) and that the 11-12-month projections remain realistic.
We also consider Marriott’s, one of the oldest financial services businesses in South Africa, forward-looking expectations which are assumed to be a longer-term absolute return expectation for the Global REIT Index, yielding between 4.5% and 6.5% p.a. This return is made up of a yield of 4.5% with an annual property rental growth of 1% to 2% over time. If a US Dollar Cash rate of 2% p.a. is assumed, this expectation would reflect a Cash plus return of between 2.5% and 4.5% p.a.
We also pay attention to long-term returns in bear and bull markets to remain in-check with reality. When using December 2007 as a base for longer term past performance, it is clear that US REIT’s experienced a long-term bull market post the credit crisis (Cash plus 5% p.a.), while non-US REITs simply recovered to their starting value pre-global credit crisis. This pattern is very much the same for US equities versus the European/UK and Emerging Market equities.
US REITs vs non-US REIT’s
An analysis on any asset class must address current fundamental risks and realities. Presently, one of our preferred global real estate managers is Catalyst. We have summarised the Catalyst fundamental outlook (not withstanding all the known risks such as higher US interest rates, global political instability, etc.) as follows:
Considering these views, my expectation for a medium term (4-5 years) US$ cash plus return for global real estate lies between 3.5% and 4% p.a. Let’s see if the rest of the team agrees!
This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors, officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) and MitonOptimal Guernsey Limited (Registration No. 40985) are both registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal Portfolio Management (IOM) Limited is licensed and regulated by the Isle of Man Financial Services Authority (Registration No. 103941C). MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial Services Provider’s (FSP’s). MitonOptimal South Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242) Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).