By: Paul Curbo, Portfolio Manager, Invesco Real Estate
Globally, real estate securities were down around 3.6% during the second quarter, as measured by the FTSE EPRA/NAREIT Developed Real Estate Index, likely driven by interest rate fears around and world and, specifically, the increase in US interest rates sparked by Federal Reserve Chairman Ben Bernanke's comment in May about tapering the Fed's bond-buying program.
But fundamentals remain quite good, which tends to support share prices over the longer term. In addition, because the market underperformed somewhat during the second quarter, valuations have improved modestly.
Here's a snapshot of major global real estate markets:
- US: Rents are accelerating, and we believe that because of the relative lack of new construction, the current window of improving occupancy rates and rents will likely be longer than in past market cycles.
- Europe: This market also has a relatively low level of new supply. The region is a little more bifurcated than previously, with some countries experiencing economic growth, while others in a slump.
- Asia: The market is incrementally a little worse, in part due to the slowdown that we've seen in China. Some markets, such as Singapore and Hong Kong, are trading at significant discounts to net asset value.
- UK: The UK was a relative outperformer during the second quarter, moving from a 2% discount to a 4% premium.1
- Canada: This market underperformed — moving from a 4% premium to a 6% discount during the quarter — likely because of global interest rate fears.1
Our strategies: second-quarter review
We manage three distinct real estate securities strategies: a US total return strategy, a global total return strategy and a global income-oriented strategy. Overall, our positioning is toward lower-leveraged companies. Although our relative performance improved somewhat during the quarter, our quality bias has been a performance headwind because higher-leveraged companies have been rewarded with better share price performance.
US strategy: The US has presented some performance challenges for much of 2013 because of investors' focus on yield and the resulting inflows into REIT ETFs. However, ETF flows moderated during the second quarter, and our strategy outperformed the index.
Global strategies: Our global strategies underperformed their indexes slightly during the second quarter.
Relative to the index, our global total return strategy experienced positive stock selection, but negative market allocation. In particular, stock selection was strongest in Japan, the US and Canada, while weakest in Hong Kong and Singapore. An underweight in the US hurt relative performance.
Our global income strategy, not surprisingly, has underperformed relative to equities over the past year because of positioning toward fixed income and preferred shares — which don't perform as well in a rising interest rate environment. But the strategy is currently positioned slightly more toward common stocks, which offer better valuations and long-term growth opportunities. The fixed income component of the strategy provided good yields during the quarter and continues to have short duration as we expect rates to continue rising from here.
As fundamental real estate managers, we believe stock selection — rather than country or currency weights — offers the best opportunity to add value. As a result, we don't focus on macro issues including government or central bank policy.
Over the longer term, we believe our bias toward lower-leveraged, better-quality companies essentially eliminates from consideration those companies with a lower outlook for their markets, lower quality of management and assets, lower corporate governance and higher financial leverage. That has presented a tremendous performance headwind for us over the last several years.
Typically, lower-leveraged companies should benefit in a rising interest rate environment because they don't have negative headwind of costs associated with higher rates affecting cash flow per share. That wasn't the case during the second quarter. Although there was an immediate price reaction to rising rates, we don't believe it was an efficient market that effectively discerned between companies according to their leverage. In our view, lower-leveraged stocks will be rewarded with better valuations over time, and we believe our strategies are poised to outperform in a more normalized environment with more interest rate volatility. Overall, we feel positive about the longer-term prospects for returns and our strategies.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
The investment techniques and risk analysis used by the portfolio managers may not produce the desired results.
The strategy may hold illiquid securities that it may be unable to sell at the preferred time or price and could lose its entire investment in such securities.
Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.
Junk bonds involve a greater risk of default or price changes due to changes in the issuer's credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
Debt securities are affected by changing interest rates and changes in their effective maturities and credit quality.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
Credit risk refers to an issuer's ability to make timely payments of interest and principal. Because the strategies generally invest only in investment grade-quality debt securities, it is subject to a lower level of credit risk than a strategy investing in lower-quality securities.
To the extent, invest a greater amount in any one sector or industry, the strategy's performance will depend to a greater extent on the overall condition of the sector or industry, and there is increased risk to if conditions adversely affect that sector or industry.
Mortgage- and asset-backed securities are subject to prepayment or call risk, which is the risk that the borrower's payments may be received earlier or later than expected due to changes in prepayment rates on underlying loans. Securities may be prepaid at a price less than the original purchase value.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
An investor should consider each vehicle's investment objectives, risks, charges and expenses carefully before investing. Please read the prospectus or other offering documents carefully before investing. For this and more complete information about the strategy discussed and the available investment vehicles, contact your Financial Advisor.
FOR US USE ONLY
|NOT FDIC INSURED
||MAY LOSE VALUE
||NO BANK GUARANTEE