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Protecting Real Returns with Real Estate

2020 and the COVID-19 experience are going to be hard to forget. It was a roller coaster of a year in terms of economic activity, market reactions and indeed, on a personal health and wellness level for many. The self-inflicted lockdowns resulted in restrictions on mobility and a seizure of economic activity. The coinciding collapse in demand was unprecedented and led to deflationary pressures throughout the World. Fast forward a year or so and the deflationary concerns that propelled policy makers into action have turned into inflationary threats causing investors to reconsider traditional allocations. Central banks have referred to the recent inflationary pressures as being “transitory” and have guided towards continued monetary support until unemployment is controlled. The closely followed minutes and dot plot from the Federal Reserve’s July meeting suggest that interest rates will start to rise from 2023, although the process of tapering asset purchases could begin sooner if conditions permit. Investors will closely watch guidance for asset purchases at the next policy meeting in September, but having experienced the ‘taper tantrum’ in 2013 and the fall out it created in risk assets, policy makers may choose to stay behind the curve.

With vaccinations in full force and fiscal stimulus of trillions planned, recent inflation and growth releases may be pointing towards a changing macro environment. July’s US Consumer Price Inflation reading was 5.4% year over year, following two consecutive months at or above the 5% level. Similarly, inflationary pressures are prevalent in the UK with the yearly Consumer Price Inflation exceeding the 2% level for two consecutive months before settling at the Bank of England’s target during July. Although the most recently published figure would suggest a cooling of UK inflationary pressures, policy makers and economists are expecting inflation to average above the 2% target for the rest of the year. Supply chain bottlenecks and a revival of demand have resulted in shortages across almost all inputs of production, from steel to semiconductors, driving up prices across the board. Companies have been forced to become smarter in procuring raw materials, drive internal business efficiencies or ultimately pay up. While there may be questions around the persistence of inflation, there are increasing signs of sticky prices and structural shortages, particularly in labour and material costs - a reason to believe that the recent pressures may be more than just “transitory”.

As upside risks to inflation prevail, the benefits of investing in Real Estate are worth reassessing. Listed real estate equities, such as REITs, are a relatively more liquid route to access the asset class. Investors should consider their own risk appetites as REITs are more volatile than direct property investments however, the sector provides traditional benefits of income and diversification while bypassing liquidity risks experienced by bricks and mortar open ended funds. Moreover, if REITs are analysed through a sustainability lens, this can lead to exposure in companies that benefit from improved pricing power and a lower cost of capital. Best in class REITs can attract superior tenants, who have their own sustainability initiatives, that are willing to pay a premium for environmentally sustainable and high quality space. The ability to demand higher rents or incorporate indexation into lease contracts are signs of pricing power, which ultimately protect the real return for investors.  Furthermore, with a backdrop of easy monetary conditions, companies can continue reducing and fixing their cost of debt to improve their cost of capital. With the total issuance of global “green” debt now close to exceeding $3 trillion, continued demand for and supply of sustainability linked debt should allow certain companies to benefit from relatively lower interest rates.

With an investment landscape that is leading investors to reconsider traditional portfolio allocations, we believe Real Estate exposure through REITs offers a compelling portfolio solution. REITs can provide exposure to structural growth trends and inflation linked income, characteristics lacking from cyclical equity income or high yield strategies. Although the macro environment continues to evolve, an end of fiscal austerity and continued monetary accommodation in some form ultimately bodes well for real asset prices. The Foresight Sustainable Real Estate Securities Fund targets a 4% net yield via a portfolio of REITs, managed with sustainability factors at its core. The focus since launch has been to build a portfolio that reduces equity market sensitivity via a diversified approach to Real Estate. Our philosophy has naturally led us towards sectors where we see the best inflation and risk adjusted returns with high quality asset backing. Having recently passed its first anniversary, we have successfully delivered on the Fund’s objectives with a low correlation to wider equity markets, providing investors with a credible income alternative in a World where a scarcity of yield continues to prevail.

Aqib Hashamali, CFA, Foresight Capital Management

All data referenced in the article is from publicly available data sources and Bloomberg. We recommend that investors seek professional advice before deciding to invest as capital is at risk.

This has been approved as a financial promotion for the purposes of Section 21 of the Financial Services and Markets Act 2000 by Foresight Group LLP (“Foresight Group”). Foresight Group is authorised and regulated by the Financial Conduct Authority (FRN 198020) and its registered office is The Shard, London SE1 9SG. FundRock Partners Limited is the authorised corporate director of the Foresight Sustainable Real Estate Securities Fund and Foresight Group is the investment manager.