The takes long and short positions in listed securities exposed to assets such as office and industrial real estate, residential development, retail shopping centres, airports, ports,toll roads, rail and utilities. Investment Objectives Generate returns of between 12 15% per annum over rolling three year periods Target portfolio volatility of less than 15% Average Fund Statistics for Octber 2015 Number of positions: 15-20 Net Position: ~25% long Fund Performance Total Long Positions: ~40% Total Short Positions: ~15% Gross Exposure: ~55% (longs + shorts) JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC YTD 2013 0.52% 4.22% 2.79% 2.14% 1.93% -0.19% 11.90% 2014 0.57% 1.01% 1.21% 1.69% 1.71% 1.34% 1.80% 1.75% 0.36% 1.73% 0.81% 3.22% 18.59% 2015 1.49% 1.11% 0.23% 1.53% -1.77% 1.81% 1.45% -0.65% -1.38% 1.29% 5.33% Performance Rolling Quarter: -0.76% Rolling 12 month: 9.56% Since Inception total return: 39.72% Since Inception annualised return: 15.41% Observed daily volatility: ~5.1% Positive monthly returns since inception: 89% Attribution Positive Contributors: Negative Contributors: Folkestone Education, Mirvac and APN Property Sydney Airport, Transurban and GPT Group Fund Profile Trustee: Major Shareholders of the Trustee: Fund Managers: Firm Funds Under Management: Freehold Capital Partners Pty Ltd, AFSL 344 188 ASX listed Treasury Group (TRG) and Freehold Executives Andrew Smith Prime Broker and Custodian: UBS AG Administrator: Middle Office: Auditors and Tax: Legal: Regulator: AUD $360 million Citco Fund Services Mainstream BPO PricewaterhouseCoopers DLA Piper Australia Australian Securities and Investment Commission (ASIC)
Fund Commentary The fund delivered a positive 1.29% for the month of October. The S&P/ASX300 equity index delivered a positive 4.4% return for the month. We maintained a modest net long market exposure during the month which contributed to the positive performance this month. We are now moving into the seasonally strongest period of the year for equity returns. We will be using the fund's mandate to increase the net long exposure as opportunities present themselves. Most likely names such as Mirvac, Westfield and Goodman Group will be targeted. On the short selling side, we will be looking for names that have bounced ahead of fundamentals and may present a good case for acting as a "pair's"trade to capture the relative mispricing between two similarly exposed stocks. Since Inception Performance from June 30th 2013 Fund returns remain solid, with low levels of volatility The Fund continues to deliver solid absolute returns with low levels of volatility, the chart below highlights this. 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% July August September October November December January February March April May June July August September October November December January February March April May June July August September October Source: Freehold Investment Management Monthly Cumulative
Stock of the Month Mirvac Mirvac Group is an integrated, diversified Australian property group comprising an investment portfolio and a development business. The Company's investment portfolio, Mirvac Property Trust, invests in and manages office, retail and industrial assets and the development business has exposure to both residential and commercial projects. The Passive Investment Capital (Trust) has assets of $7.5bn and represents 82.4% of the total. The Active Investment Capital (Corporation) has assets of $1.6bn (17.6%). Further analysis reveals the Trust breakdown as 55% Office, 28% Retail, 9% Industrial and 8% Other (Hotels, Carparks and Investment Properties Under Construction (IPUC)). The Corporation is divided 91% into Residential (Apartments 60% and Master Planned Communities 40%) and 9% Commercial (78% Office and 22% Industrial). The Portfolio and Strategy Office (55% of Trust) Mirvac seeks to create and buy Office buildings. They are targeting prime grade CBD assets (development, repositioning and passive). For non-cbd prime grade they aim for development and repositioning opportunities. Retail (28% of Trust) Mirvac targets ownership of irreplaceable assets in high density populated areas with deep employment markets and affluent demographics with rising household wealth. Industrial (9% of Trust) Mirvac wants to create and hold these assets. They look for infill ring repositioning and up-zoning. This is a form of urban edge tenant driven development. Residential Development (91% of Corporation) Mirvac is looking to create and sell this form of asset. They target the inner ring of cities, apartments in metropolitan activity centres, master planned communities in infill locations and master planned communities on the urban edge. Why have we been buying Mirvac? We think MGR s share price is being overly penalised for its residential development division. As shown above, MGR is actually a diversified real estate company with interests spread across Office, Industrial, Retail and Residential Development. Residential On the residential side we are all aware of the slowdown in the rate of house price growth. Official RP Data statistics are showing this. Further, the auction clearance rates across New South Wales and Victoria are slowing to be within the mid 60% to low 70% range. Highs over the last year have nudged 80+%. Some industry participants suggest 50% clearance rates are a rule of thumb for a market in equilibrium. Using this method, pricing power still sits with sellers and would justify more house price growth (albeit at a slower rate). At the October operational update, Mirvac appeared to be as transparent as possible regarding this division. They announced that the Financial Year 2016 will see 2,900 lots settled. Importantly, contracts on hand represent $2.3bn and this means 79% of FY16 is already secured and 66% of FY17. This gives us some comfort that negative shocks appear less likely for the next two years. Statistics relating to the $2.3bn contracts on hand: New South Wales 60%, Victoria 24%, Queensland 13% and Western Australia 3% Apartments 75%, Master planned Communities 25% Buyer profile 41% owner occupied, 33% investors, 19% Mainland China and other offshore 7% In our valuation, we use a sustainable residential development earnings figure to avoid falling victim to the trap of capitalising peak cycle earnings with peak cycle multiples. We think the market is shooting first and asking questions later in this respect and has already de-rated the stock over the past year. Over the last year (to 31 October) the stocks with residential exposure have all suffered. Mirvac is only up 5.8%, Stockland up 1.1% and Lend lease down 13.5%. This compares to the AREIT market being up 18.3%. A topical risk getting lots of attention presently is settlement risk. We estimate that buyers on average are 5% in-the-money on their apartment purchases. We know they pay a 10% deposit meaning the price would have to fall 15% before Mirvac is at risk of an earnings downgrade. If an apartment was handed back to Mirvac, they would be entitled to re-sell it into the open market. The two biggest drivers of Mirvac are the sustainability and predictability of earnings from its residential development business and the valuation of the Office portfolio.
Office We have been sceptical of an office market recovery for some time, however, the first signs may be appearing for our view to change. Some of the information is well and truly old now including the Barrangaroo development site in Sydney s CBD. It is adding 11% to the total premium and A grade space. As a comparison, Melbourne s Docklands expansion was just over 20%. Net absorption (the difference between supply and demand) is improving in Sydney. The missing piece of the recovery puzzle remains incentives. These are still hovering above 20% and in some cases above 25%. This suggests to us that pricing power is still with tenants and makes increasing effective rents difficult. Looking forward to vacancy, some commentators are suggesting Sydney CBD vacancy will hit 12.9% by December 2016, then fall to 8.6% by December 2017. The long term average is 8.0%. If this proves to be true, the market would be in equilibrium. Even if there is a perception of this occurring, it may stimulate tenants to lock in future leases ahead of a tightening market. This change in psychology may become self-fullfiling and drive rents higher as less space is available. Probably the most significant event for the office sector this year has been the Morgan Stanley sell-down of assets. In July 2015, the China Investment Corporation (CIC) paid $2.5bn for stakes in Investa assets held by Morgan Stanley. Importantly, this established transactional valuation evidence for property valuers. Knight Frank estimated a core yield of only 5.6% for the transaction. Admittedly some of this pricing reflects a portfolio premium effect whereby a buyer pays more to secure a large line of assets that seldom come to market. We think this evidence supports significant capitalisation rate compression. Based on the CIC purchases and look-through capitalisation rates for Dexus and Investa, we have firmed overall capitalisation rates for MGR by 30 basis points. This may be conservative. Our valuation for the whole group is shown below: Valuation Cap rate Valuation Trust NOI (2016) $516 6.7% $7,701.49 Development EBIT (Resi & Commercial) (Based on 3 year estimate) Investment Management EBIT 2016 Multiple Valuation $268 12 $3216.00 $7 15 $105.00 Corporate costs -79 12 -$948 Total Enterprise Value $10,074.49 Net Debt -$2754.00 Net Asset Value $7,500.49 Shares 3700.9 Net Asset Value per share $2.03 As the stock has recently traded down near its net tangible asset backing of $1.74, we have been adding to the position. On a look-through basis, we believe the resulting capitalisation rate paid for Grosvenor Place, Sydney was 5.46% and is 54 basis points below the 6.0% capitalisation rate Dexus holds its 37.5% interest at. Similarly, 126 Phillip Street, Sydney at 5.16% or 59 basis points below Investa s book value. As can be seen in the table below, the Mirvac and Investa portfolio are of a similar quality based on capitalisation rate (used for the determination of the net tangible asset backing) and the occupancy (reflecting the quality of the asset and its attractiveness to tenants). Mirvac Investa Dexus GPT Capitalisation rate 7.0% 6.9% 6.7% 6.3% Occupancy 94.0% 93.0% 95.3% 95.0% Source: Company presentations
Catalysts Along with the prospect of improving office markets and a large discount to valuation (based on a sustainable residential development earnings number) other catalysts exist which could help the share price rise. They include: 1. Restructure - At the Annual General meeting on 12th November, the Chairman made some interesting comments that caught our eye. Overall, the business is in great shape and performing well. The achievements I have just outlined across all parts of the Group demonstrate the success of the strategy put in place a few years back. However, it is clear to the Board and management that despite these considerable achievements, the market does not value the business in a way that fully reflects the performance of our high quality portfolios. As a result of this, the Board and management are currently assessing how we can unlock the full value of our business, while ensuring that we can maintain the benefits of our creation and development capabilities. We will of course keep you updated on our findings as we progress with this analysis. We think there is a prospect of separating the development business away from the trust. This would enable full value for the trust to realised as investors compare the fundamentals such as capitalisation rates and occupancy to like companies. The development business could then be listed separately to achieve more value than is currently being implied from the share price. Alternatively, a JV partner could purchase a stake in the business providing price discovery for its true worth. 2. Corporate Activity - Something spoken about from time to time is Mirvac being the target of corporate activity (a takeover). If this was to occur, we think the shares would trade well in excess of $2.00. There is no evidence of this occurring, it is just a possibility. Summary All things considered, based on the potential office recovery (and firming capitalisation rates), the residential development business currently being priced for disaster, the prospect of a corporate restructure, a possible takeover and reasonable discount to our conservative valuation, we think Mirvac looks like a good long position for us to buy on weakness.
Important Disclaimer this may affect your legal rights: Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives, you should consult your investment adviser before any investment decision is made. While this document is based on the information from sources which are considered reliable, Freehold Capital Partners, its associated entities, directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Freehold Capital Partners accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document. This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Freehold Capital Partners. This is general securities advice only and does not constitute advice to any person. Disclosure of Interest: Freehold Capital Partners and its associates may hold shares in the companies recommended. The individual fund performance figures are based on an investment in the Fund s June 2013 Series made on July 1st, 2013, the date of the Funds inception. The performance numbers are based on the net asset value of the Fund and are calculated net of management fees, brokerage commissions, administrative expenses, and accrued performance allocation, if any, and include the reinvestment of all dividends, interest, new issue income or loss, and capital gains. The Firm and the Fund have a limited operating history. This report is not an offer to buy or sell any security. Offering by private offering memorandum only. Investing in hedge funds such as the Freehold Absolute Return fund is risky and investors are exposed to capital loss. Investors should review the offering memorandum for the Fund, which contains a complete description of the investment program and its risks, in its entirety before investing. The Fund focuses on real estate and infrastructure investments, which can be volatile and subject to market factors beyond the control of the manager. Certain information provided herein is based on third-party sources, which information, although believed to be accurate, has not been independently verified. The Firm assumes no liability for errors and omissions in the information contained herein. This report is for informational purposes only and may not be reproduced or distributed without the prior consent of the Firm. Volatility is calculated by using the annualised standard deviation of monthly returns since inception of the. Standard deviation measures the distribution of returns around the mean return. Low standard deviations reflect low variation in monthly results; higher variability is usually interpreted as higher risk. Standard deviations are based on monthly results, and then annualised. The Sharpe Ratio is the ratio of excess return to volatility. Excess return is defined as the annualised rate of return less the risk-free rat), using monthly returns since inception. The volatility measure is the annualised standard deviation of monthly excess returns since inception. Reference to the S&P 500, the MSCI REIT Index are not intended to imply that the Funds invest in securities in such indices, are intended to track such indices, are invested in a manner similar to such indices, or will achieve returns, volatility or other results similar to such indices, but rather serve as an indication of the correlation between the performance of the Funds and the performance of such indices. Indices are unmanaged and cannot be invested in directly. Any investment in the Fund is speculative and involves substantial risk, including the risk of losing all or substantially all of such investment. No representation is made that the Funds will or are likely to achieve their objective, that any investor will or is likely to achieve results comparable to the estimated performance shown, will make any profit at all or will be able to avoid incurring substantial losses. Past performance is not necessarily indicative of future results. Year to date figures are calendar year returns, based on a hypothetical January 1st investment for each year. Comparisons of the performance of actively managed accounts such as the Funds with passive securities indices involved material inherent limitations. Performance estimates are presented only as of the date referenced above and may have changed materially since such date. Freehold Capital Partners Pty Ltd ABN 79 139 750 673 AFS Licence No. 344188