Australian investors who seek diversification by coupling Australian shares with domestic residential investment property are not obtaining the benefits they seek, says Chris Bedingfield from Quay Global Investors.
“With more than 35 per cent of the S&P/ASX 200 represented by banks and other financials, and approximately 60 per cent of the banks’ assets in residential mortgages, it means any meaningful decline in Australian property values will impact a large proportion of the Australian equity market at the same time.
“In an extreme scenario, where diversification is most valuable, a portfolio of Australian residential property and shares may offer no real diversification at all as the two asset classes could turn out to be highly correlated.
“Any stress in the Australian banking system resulting from a decline in residential property will have a significant impact on the wider Australian economy and therefore a meaningful impact on the entire share market.”
A better option for property investors would be to diversify into a global property exposure, he says.
“An important aspect for portfolio construction is to allocate capital to un-correlated asset classes while maintaining an overall return objective.
“Assuming most Australian investors want to maintain a significant holding in Australian equities, and they like the idea of property investments, this means finding alternative asset classes with little correlation,” Mr Bedingfield says.
“An obvious option might be an exposure to global equities. But interestingly our analysis shows the correlation between global equities and Australian equities is almost the same as between global real estate and Australian equities.
“Statistically, the correlations sit at 0.50* and 0.51* respectively. Putting this into context, the closer the correlation is to a value of 1 the more correlation there is between asset classes, hence less diversification.
“Obviously, there is as much diversification benefit for an Australian investor to allocate to global real estate as there is to global equities; investors who see the benefits of real estate assets could find this attractive.”
Mr Bedingfield says: “In addition, global real estate offers greater diversification against Australian equities (with a lower correlation at 0.51*) compared to Australian real estate investment trusts (that sit at 0.62*).”
Not a bond proxy
Finally, despite conventional wisdom that real estate is a ‘bond proxy’, global real estate has almost no long-term correlation with global fixed income (at 0.05), Mr Bedingfield says.
“The low correlation indicates that holding both asset classes offers significant diversification while providing income-based total returns.”
Real assets rarely lose all of their value
Mr Bedingfield said another big advantage for real estate – and other real assets strategies – is that real estate companies grow by acquiring real assets.
“So long as leverage is managed, real assets rarely lose all of their value. Companies may pay too much – but the assets retain some value even under a worst-case scenario. The rate of obsolescence for institutional quality property is low.”
The same however, can not be said for equities.
“In the world of equity, operational leverage can turn seemingly sensible acquisitions to dust if there is any technology industry disruption (as was the case for MySpace) or if there is poor judgement (as was seen with Slater & Gordon / Quindell). In our view, the rate of business obsolescence is greater than real estate obsolescence.”
Unhedged global real estate also stacks up on a total annual returns point of view, and has delivered returns comfortably above the long-term inflation rate and competing assets.
“Looking at sector performance since 2000*, global real estate has been a top four performer on 11 out of 17 occasions. Australian equities (which has been a top four performer nine times) and US Equities (eight times) have not been as consistent.
“Interestingly, whenever global real estate has performed relatively poorly, it has bounced back strongly in the following years.
“Equally, the volatility of global real estate is not significantly different to other risk assets.
“For Australian investors, global real estate provides as much diversification as global equities – with a better return track record. It is likely therefore to provide much needed diversification even for investors who hold domestic property,” Mr Bedingfield says.
*Source: Bloomberg and Quay Global Investors
About Bennelong Funds Management
Bennelong Funds Management is a boutique fund manager nurturing a growing suite of asset management teams. Bennelong’s boutique partners collectively manage over $7.5b in funds under management. Bennelong is a wholly owned subsidiary of the Bangarra Group (formerly known as the Bennelong Group), a privately owned company encompassing a number of independent businesses.
About Quay Global Investors
Quay Global Investors is a boutique investment manager focused on the preservation and creation of wealth through innovative strategies in real estate securities.
Quay was launched in May 2015 as a partnership with principals Justin Blaess and Chris Bedingfield and Bennelong. Prior to this, the business operated as Quay Real Estate Advisors which was founded by Justin and Chris in 2013.
The founding partners have over 40 years of collective experience in direct property, equities research, investment banking and investment management across domestic and global markets, giving them a unique skill set and perspective which they bring to the management of a portfolio of global real estate securities.