Schroder UK Property Fund

Transcription

1 Schroder UK Property Fund Core UK commercial property Portfolio update Open-ended property funds Schroder UK Property Fund (SPF) targets a blend of income and capital growth through investment in a diversified portfolio of commercial property throughout the UK. The UK property market has seen accelerating momentum over the past year; the improving economy and investor demand have supported capital values, in addition to the more predictable and sustainable income return. SPF is up 16.6% in the 12 months to June 2014 and has performed well versus its peer benchmark over the past five years. With the economic recovery, tenant demand is improving, providing support for ongoing rental growth. Total return Fund level (NAV) Property level Direct property** % pa SPF (% ) Benchmark* (%) SPF (%) Benchmark* (%) (%) 5 years to March years to March year to March months to June 2014* 5.2 N/A N/A N/A N/A Note: *Benchmark is AREF/IPD UK Quarterly Property Fund Index All Balanced Funds Weighted Average. Property total return (TR) excludes impact of on-balance sheet gearing and fund level costs. Data for 3 months to June not yet available. **Direct property return is IPD Quarterly UK Property Index, excluding impact of transactions and development. Strategy: core with a focus on sustainable income SPF is managed by Schroder Property Investment Management, a large property investor able to support a well-resourced and experienced team and relationships with the market. A dedicated SPF investment team combines top-down and bottomup analysis to construct a core style diversified UK property portfolio focused on identifying good-quality buildings let to secure tenants, in predominantly mainstream sectors. Asset management, in moderation, supports the core strategy by seeking opportunities to invest for income and capital growth. The portfolio is underweight retail and overweight offices, particularly in the South East. Outlook: recovery is boosting expected returns Economic recovery combined with a benign inflationary outlook continues to support forecast returns for UK commercial property. The most recent market forecasts by the Investment Property Forum, comprising fund managers and surveyors) predicts capital growth will slow from 2015, but annual total returns in excess of 6% pa are expected through 2018 driven by income returns, supported by rental growth. Schroders property research team believes there is no indication that the market is nearing the top of another cycle. The main risk to capital values would appear to be a faster than expected increase in credit market yields. Yield remains relatively attractive Most forecasts point to continued economic growth, which is a support to tenant demand and rental growth. Meanwhile, the current gap between 10-year gilt yield and property yields is c 3.13%, above the 10-year average of 2.2%, providing a cushion to the expected gentle increase in UK interest rates. 15 July 2014 Gross fund assets* 1,514m Net fund assets* 1,489m NAV per share* Shares in issue* 43.0m Distribution yield** 4.1% Min. investment 100,000 *Data as at 31 March 2014 **Trailing 12-month distributions as % NAV ONLY SUITABLE FOR PROFESSIONAL INVESTORS Cumulative three-year performance to end March 2014 Index of Total Returns % Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Investment considerations Among unlisted UK property funds, SPF is one of the largest and most liquid, with an active secondary market. Structured as a PAIF, it is available to a broad (professional-only) investor base. It is managed to a core style, blending income with capital appreciation, and mitigates risk by having a diversified portfolio, clear investment limits and portfolio-monitoring procedures. Analysts SPF Martyn King +44 (0) Andrew Mitchell +44(0) financials@edisongroup.com Edison profile page B'mark Weighted Average SPF s full Q report with updated holdings and benchmark performance data is expected to be published on 22 July Schroder UK Property Fund is a research client of Edison Investment Research Limited

2 Exhibit 1: Schroder UK Property Fund (SPF) at a glance Investment objective and fund background Schroder UK Property Fund (SPF) is an open-ended investment company, which is a Property Authorised Investment Fund (PAIF). It targets income and capital growth from property in the UK. It has a target total return from investment, net of all fees and expenses, of 0.5% pa in excess of the benchmark return (the AREF/IPD UK Quarterly Property Fund Index All Balanced Funds Weighted Average) over rolling three-year periods. SPF has an internal borrowing limit of 25%. The fund is a Qualified Investor Scheme and only eligible investors (corporate, institutional and professional or sophisticated individual investors) may invest in it. The minimum investment is 100,000. Shareholder information Fund details Minimum investment 100,000 Authorised corporate director Schroder Unit Trusts Limited Annual management charge 0.30% pa of fund NAV 31 Gresham Street. London EC2V 7QA 0.40% pa of GAV direct holdings & cash Investment manager Schroder Property Investment Mgmt. Total expense ratio 0.81% 31 Gresham Street. London EC2V 7QA Distribution frequency Monthly Contact (Olivia Pember) Distribution yield (trailing) 4.0% of NAV Website Shareholder dealing information Fund literature Subscriptions Monthly Responsible property investment Redemptions Quarterly, with three months notice SPF prospectus Secondary market Yes Audited annual report & accounts Investments by segment (% GAV as at 31 March 2014) Positioning vs benchmark (% GAV as at 31 March 2014) Top 10 holdings as % NAV (as at 31 March 2014) Top 10 holdings Holding Sector Weighting Bracknell Regeneration Partnership Joint venture Retail & office 4.5% Acorn Industrial Estate, Crayford Direct Industrial 3.7% Hartlebury Trading Estate Direct Industrial 3.7% Mermaid Quay, Cardiff Direct Leisure 3.4% West End of London Property Unit Trust (WELPUT) Indirect Offices 3.3% Kensington Village, London W14 Direct Offices 3.3% Davidson House, Reading Direct Offices 3.3% Matrix Park Royal, London NW10 Direct Industrial 3.3% Monks Cross Shopping Park, York Joint venture Retail warehouse 3.0% Lemon Quay, Truro Direct Standard retail 2.7% Top 10 total 34.2% Top 10 tenants by % of contracted rent (as 31 March 2014) Tata Steel UK Ltd 3.8% B&Q Plc 2.0% Fujitsu Services Ltd 3.1% Pendragon Property Holdings 1.8% Lloyds TSB Bank Plc 3.0% Sungard Availability Services (UK) Ltd 1.5% Universal Music Operations Ltd 2.3% Marks & Spencer Plc 1.4% Regus (UK) Ltd 2.3% Homebase Ltd 1.3% Source: SPF Industrial 23% Other property 10% Cash 4% Retail 28% Offices 35% Standard retail South East Standard retail rest of UK Shopping centres Retail warehouses Offices central London Offices South East Offices rest of UK Industrial South East Industrial rest of UK Other Cash -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% Top 10 total 22.5% Schroder UK Property Fund 15 July

3 Fund profile and summary Fund description: Core UK commercial property Schroder UK Property Fund (SPF) is an open-ended investment company, incorporated in the UK and authorised by the FCA. It is one of the largest UK diversified balanced property funds available to investors, and it is among the most liquid funds (Schroders operates a secondary market in the unlisted shares) in its benchmark. It is structured as PAIF, 1 which makes it available to a wide variety of professional investors. SPF s investment strategy positions it as a core fund that provides investors with access to a diversified portfolio of UK property, focused on good-quality buildings let to secure tenants. The investment objective is to outperform its peer benchmark by 0.5% pa over rolling three-year periods through a blend of income and capital growth. Over the past one, three and five years, SPF s fund-level NAV total return has exceeded that of its peer benchmark and at property investment level (without any impact from on-balance sheet gearing or fund-level costs), returns have consistently exceeded the benchmark property total return. The three-year total return is 7.0% pa, achieving its investment target by exceeding the benchmark return of 5.7% on the same basis. The benchmark is the AREF/IPD UK Quarterly Property Fund Index All Balanced Funds Weighted Average. SPF s strategy is consistent with INREV guidelines 2 for a core investment style (eg in relation to its exposure to investment in developments and land, the level of gearing and portfolio income). Return expectations increasing; little sign of peaking Economic recovery combined with a benign inflationary outlook continues to support expected returns for UK commercial property. The most recent market forecasts by the Investment Property Forum (canvassing a group of fund managers and surveyors under the IPF Research Programme) were published in February. The median (all forecasters) expected total return on UK property for 2014 increased to 12.1% (from 9.3% in November), led by office (14.0%) and industrial (13.5%) property. Total annual returns are expected to slow from 2014 onwards, as capital growth gradually declines, although still supportive tenant demand should sustain rental growth and a total return in excess of 6% pa throughout the period to Domestic and international investors have been turning to UK commercial property for an attractive and sustainable income return with capital growth potential. This has seen downward pressure on yields, particularly on prime assets. However, underpinning the investment market is the fundamental strength of occupational demand and with GDP growth accelerating and unemployment at the lowest level for five years, tenants are becoming more confident about committing to new space. In this context, property income, a significant and relatively stable component of property returns over time, is supported by diminishing void rates and improving rent levels. Schroder property team sees no early peaking Schroders property research team believes the upswing in property returns that began in 2009 still has some way to run, and the market is not approaching the top of another cycle. Its forecast suggests that UK commercial property capital values may increase by a cumulative 10-15% by the 1 2 Property Authorised Investment Funds (PAIFs) were introduced in 2008 and allow qualifying authorised funds to avoid tax on income (at 20%) and eligible unit holders to receive income gross of tax. INREV (European Association for Investors in Non-Listed Real Estate Vehicles) guidelines have the objective of establishing and promoting a best practice reporting and governance framework within the sector. Schroder UK Property Fund 15 July

4 end of 2016, generating an annualised return of 8-10% when combined with an income return of c 5.5% pa. The key risks to this positive outlook include a stalling of economic momentum and an earlier and sharper increase in interest rates than expected. Most forecasts point to continued growth while the current gap between 10-year gilt yields and property yields (measured by the IPD All Property initial yield) of c 3% is above the 10-year average of c 2.2%, providing a cushion to gentle rate increases, which Schroders expects to reach c 4% by the end of Other indicators that have previously given an early warning sign of potential weakness in capital values, such as increasing property supply or excessive bank lending, also screen well. The structural prospects for the retail sector seem sufficiently uncertain to limit new supply over the next few years and while the same cannot be said of office property, there appears no immediate threat of an impending development boom. The available statistics on bank lending to the property sector have a number of weaknesses, and it is difficult to capture the extent of non-bank lending at all. However, anecdotally it seems to be the case that the appetite for new commercial property lending is at a relatively early stage of recovery, while bank lending statistics, for all their weaknesses, show a decline in commercial property lending as a share of total lending since Current portfolio positioning and strategy Exhibit 2 shows the sector and geographic positioning of the fund as at 31 March There were 76 holdings at this date and the portfolio appears well diversified. Exhibit 2: SPF sector/geographic breakdown as at 31 March 2014 Industrial South East 16% Offices rest of UK 5% Offices South East 14% Industrial rest of UK 7% Source: Schroders, Edison Investment Research Other 10% Cash 4% Standard retail South East 7% Standard retail rest of UK 4% Shopping centres 1% Retail warehouses 14% Offices central London 16% SPF is an actively managed fund and its current positioning versus the peer benchmark is shown in Exhibit 1 on page 2. The manager believes that owning properties with good fundamentals is crucial for generating sustainable income now and rental growth in the future, and the fund has benefited from being overweight in prime property in recent years. However, the search for safety has compressed prime yields and SPF has been seeking more good-quality non-prime assets, where rents are more affordable and asset management can add value. We highlight a number of examples of the opportunities that SPF has identified below. In addition, given the improved growth outlook, the manager has signalled a somewhat increased focus on further investing in the current portfolio to create rental and capital growth for the future. In particular, we expect further development at Bracknell town centre, where SPF is in a joint venture partnership, and at Croydon. Schroder UK Property Fund 15 July

5 Yield from regional industrial A key attraction of industrial property is yield (income return of 7.8% for IPD industrial index in the 12 months to February 2014). However, good-quality multi-let industrial property in the South East (SPF was 5.1% overweight South-East industrial property versus its benchmark at the end of March 2014) has remained sought after, driving up prices, particularly within the M25 area. As a consequence, SPF has been turning its attention to good-quality industrial property in other regions of the UK, where a significant yield gap is still available. An example of SPF s strategy in this area of the market is the April 2013 acquisition of the Hartlebury Trading Estate in Worcestershire (3.8% of NAV at 31 March 2014), which was acquired on a 10.15% net initial yield. The property is a large industrial estate with a diversified tenant base (largest tenant 11% of rents). The property has a range of unit sizes providing scope for tenants to grow their businesses, offers a high level of security, and has achieved a high tenant retention (c 90% over the past five years) based off attractively low rental levels. Yield from opportunistic retail SPF continues to be strategically underweight in retail property (it was 9.3% underweight versus its benchmark at 31 March 2014). However, using its proprietary research (Clever Towns), SPF has identified a hierarchy of retail opportunities, differentiating high streets (and their prospects) by their consumer profile, their local urban identity, and their geography. The acquisition of the multi-let retail parade in Lemon Quay, Truro, in late 2013 is an example, targeting a regional centre that SPF had identified as being supported by a strong tourist trade and a lack of big city competition. Lemon Quay (2.7% of NAV at the end of March 2014) was acquired on a net initial yield of 6.65%. Its tenants include Cornwall s leading Marks & Spencer store and Debenhams, together more than 42% of income. SPF sees asset management potential to reconfigure some of the smaller units, and perhaps incorporate another dominant retailer. Emerging London office locations The London economy remains buoyant and investor interest in office property, both from UK and international investors, has been strong. SPF has been overweight in Central London office property (3.1% versus its benchmark at 31 March 2014), but attractive opportunities in prime central locations have diminished. SPF sees continuing opportunities, both rental and capital growth, in chosen emerging office locations with potential to benefit from significant regeneration and new transport links. Battersea Studios in SW8 is an example of such an emerging office location, supported by the relocation to the area of the American Embassy, the redevelopment of the Battersea Power Station site, and London Underground s Northern Line extension. It is a twobuilding office campus (totalling 108,000 sq ft) that was purchased in Q for 35m with a low average passing rent ( per sq ft), providing potential for rental growth enhanced by asset management initiatives, perhaps including potential change of use. Continued interest in alternatives The manager has identified a number of assets that are often less correlated with the economic cycle, but benefit from changes in the demographic profile. These can often offer above-average yields, backed by sound tenants with good business models and long leases. Examples are student accommodation, car showrooms and, more recently, care homes. Suffolk Care Homes (1.1% of NAV as at March) is a portfolio of five freehold assets, each planned to provide 60- to 80-bed modern, purpose-built care home facilities for delivery during The properties, let to Care UK on a 30-year RPI-linked lease, are yielding in excess of 7%. The investment is supported by the aging demographics of the population, and the income stream, uncorrelated with the economic cycle, provides portfolio income diversification benefits. Schroder UK Property Fund 15 July

6 Performance Over the past one, three and five years, SPF s fund-level NAV total return has exceeded that of its peer benchmark, and at property investment level, returns have consistently exceeded that of the benchmark. The three-year total return is an annualised 7.0%, achieving its investment target by exceeding the benchmark return of 5.7% on the same basis. The benchmark is the AREF/IPD UK Quarterly Property Fund Index All Balanced Funds Weighted Average, which is an index that measures the performance of 25 balanced property funds. Exhibit 3: SPF performance versus benchmark % change Quarter ending Calendar Year ending Annualised over last Jun 13 Sep 13 Dec 13 Mar 14 Yr to date Mar 10 Mar 11 Mar 12 Mar 13 Mar 14 3 years 5 years 10 years Trust Level Return (%) Fund PFI Weighted Average Relative Return (0.6) (2.5) Property Total Return (%) Fund IPD Benchmark Relative Return (0.4) (2.4) Source: Schroders, IPD. Note: *Benchmark is AREF/IPD UK Quarterly Property Index All Balanced Funds Weighted Average. The strength of performance in recent years leaves SPF s 10-year NAV total return, covering the period of the financial crisis, in line with the benchmark, and the property total return ahead. SPF underperformed during the financial crisis, largely as a result of having too much gearing going into the bear market, much of it in a relatively large aggregate exposure to indirect investments, some of which were forced to crystallise losses to preserve their financial strength. Strategic repositioning of the fund since, under new senior management leadership, has seen debt and indirect investment reduced materially. Attribution analysis shows broadly based gains Exhibit 4: Components of SPF 3-year performance versus benchmark (to 30 March 2014) Trust Total Return Property Total Return SPF 7.0 SPF 8.7 Benchmark 5.7 Benchmark 6.8 Relative 1.2 Relative 1.8 Income Return Capital Growth Attribution Relative Attribution Relative SPF 5.6 SPF 3.0 Return: Return: Benchmark 6.0 Benchmark 0.8 Structure Score Property Score Relative -0.4 Relative 2.2 SPF 0.8 SPF 0.9 Rental Value Growth Yield Impact SPF 1.4 SPF 2.4 Benchmark 0.5 Benchmark 1.0 Relative 0.9 Relative 1.3 Held Purchased Development Sold Indirect Source: Schroders, IPD An analysis of the three-year performance to 31 March 2014 shows an annualised return for SPF of 7.0% versus the benchmark 5.7%, outperformance of 1.2%. At the property level, which ignores any impacts from fund expenses or on-balance sheet gearing, SPF returned 8.7% pa versus the benchmark 6.8%, greater outperformance of 1.8%. SPF s income return is below that of the benchmark during the period, at 5.6% pa versus 6.0%, but the difference has been narrowing as the manager has sought higher-yielding assets to support an increase in the distribution yield. The shortfall on income has been made up by capital return, which at 3.0% was ahead of the Schroder UK Property Fund 15 July

7 benchmark return of 0.8%. The capital value outperformance has been supported by both a stronger valuation yield impact (2.4% pa versus 1.0%) and faster rental growth (1.4% versus 0.5%). The outperformance versus benchmark can also be analysed in terms of structure score (or sector mix) versus property score (or property selection within the sector mix). SPF benefitted from a positive score for both, with structure adding 0.8% pa over the three years and property selection 0.9% pa. Similar drivers of performance attribution are observable over the past 12 months. SPF has a target to increase the sustainable distribution yield (aggregate monthly distribution over the previous 12 months as a percentage of NAV) on the portfolio to c 5%. At 4.1% in the year to March 2014 it was lower than the peer benchmark average of 4.4%. Specifically, the manager has been reinvesting the proceeds from sales of lower-yielding assets into good quality higher yielding secondary assets. As a result, the distribution gap versus the benchmark has already been reduced as the fund had an annualised quarterly distribution yield at the end of Q of 4.4%. Schroder Property s resources and expertise More than 40 years experience Schroders has managed property funds since 1971, and had 11.0 billion under management at 1 March Schroder Property Investment Management Limited is the investment manager of SPF. The property team operates from six offices across Europe and manages a broad range of open and closed ended property funds, offering investors exposure to both diversified and sector focused portfolios A well-resourced investment team with strong oversight The SPF management team is led by Fund Manager James Lass, who is responsible for the fund strategy and performance. James joined Schroder Property in 2006 from Savills and became SPF s fund manager in The SPF investment team consists of 11 members, eight of whom are chartered surveyors, organised around sector specialisations (eg retail, business space and alternatives). Further support is provided to the investment team by the Schroder Property research team, consisting of three members, who work closely with the Schroder Group economists, and can draw on the wider equity and credit analysis resources of the group. Schroder Property s investment approach is based on a belief that the commercial property market is fragmented and inefficient. The investment process then seeks to deliver outperformance through detailed research and analysis, enhanced by an extensive network of industry contacts built over many years and supplemented by asset management. Additional fund details SPF is an unlisted investment company with variable capital (open-ended) incorporated in England and Wales and authorised by the FCA. It is a Qualified Investor Scheme and only eligible investors (corporate, institutional and professional or sophisticated individual investors) may invest in it. The minimum investment is 100,000. Previously named Schroder Exempt Property Unit Trust, it converted to a PAIF in July As a result, it is available to a wider range of UK and foreign professional investors, including insurance companies, diversified multi-asset funds, financial institutions and discretionary asset managers. The portfolio is externally valued, the majority by BNP Paribas Real Estate, appointed on 31 July 2012, with a smaller amount valued by Allsop. Schroder UK Property Fund 15 July

8 There are strict guidelines about what the fund can and cannot do to qualify as a PAIF, particularly with regard to the proportion of company net assets and income that should be derived from property investment business (a minimum 60% in case). The fund is also governed by the rules set out in its prospectus. In addition, the manager works to a number of self-determined product limits in managing the fund, designed with the aim of meeting the investment objective, while at the same time balancing portfolio risk. The annual management charge is 0.3% of NAV plus 0.4% of the gross asset value (GAV) of directly held properties and cash. Calculated in accordance with AREF guidelines, the total expense ratio including valuation, depositary, registrar and management fees was 0.81% as at the end of March SPF publishes an updated NAV on a monthly basis, calculated using a standard method applied to AREF funds (which is net of fees). Although not listed on any exchange, like a number of other funds that are either closed ended or operate with quarterly redemption facilities, there is a liquid secondary market in SPF shares supported by the ACD. Of 56 similar funds (offering monthly or quarterly liquidity) monitored by IPF, SPF is one of only four to have traded in every quarter of the past three years (20 of the 56 traded in the final quarter of 2013). Moreover, the average amount traded in a quarter (2.1% of NAV) is among the largest of the consistently trading funds. For investors that cannot be satisfied through the secondary market, new shares can be subscribed for each month and shares can be redeemed quarterly, subject to a three-month notice period. For further information see f. Edison, the investment intelligence firm, is the future of investor interaction with corporates. 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