Domestic listed property recovered strongly over the quarter, posting a return of 9.2%. This brings the return for the sector to 7.8% for the year to date, and to 20.1% over the past year. The performance for the quarter was on the back of flat bond rates, with the All Bond Index performing in line with cash over the quarter at 2.1%.
The fund performed well over the quarter, with a return of 10.2%. This brings the return for the year to date to 9.9% and for one year to 18.1%. We were of the view that property had been oversold during the June quarter, and as such had increased exposure during this sell-off, and the further sell-off during July. These purchases have added materially to performance over the quarter. Domestic listed property exposure within the fund now stands at 92%, compared to around 78% at the end of the March quarter.
The fund also benefited significantly from the maximum permissible 10% holding in Liberty International. We have long argued the merit of this investment, and the attraction of a negative correlation to domestic listed property, and this view has finally come through on the back of a weaker currency, and also a strong performance in Pound terms. Liberty International returned 25% over the quarter, and 65% in the year to date.
On the back of this strong performance we have started reducing exposure materially. The share is now trading well over 1200 pence, and given the current level of the Rand we believe it is now overvalued. Given the important diversification benefits within the fund we are hesitant to sell the position out completely, but will do so at the right price.
Going forward we believe there is still selectively good value in domestic listed property. On aggregate we are expecting an annualised return around 10% over the next three years for the sector. This is based on an assumption of fair value around 9.1% for RSA long bond rates, which is still around 50bp above current bond rate levels. Interestingly there is still big divergence in the expected returns for individual property companies, with the highest at the time of writing being 15.7%, and lowest -5.2%. We thus think that stock picking will be very important in the next year or two going forward.
Interestingly, interest rate expectations in the market have become significantly more bearish since the writing of the last report. At that stage, many economists were arguing that the first 50bp increase in interest rates may be a one-off. One rate increase later and expectations have in our opinion swung from being too bullish to being too bearish. The FRA curve is now discounting a further 150bp increase within the next 12 months, and many commentators are warning against further increases of 3-4%. We believe these expectations are overdone (expecting at most a further 2-3 50bp increases), and as such creating opportunity in the listed property market.
We believe fundamentals for the sector remain good. Growth expectations have in fact increased marginally to 11.1% and 9.5% for the next two years respectively. Importantly though, given our interest rate expectations, we do not see a material negative change to medium term fundamentals for the sector. The average property stock is now trading at a clean forward yield around 9%, and premium to NAV of 20%, which is quite reasonable in our opinion.
We are sticking to our view of positioning the fund in the quality counters with more robust rental streams through the cycle. Despite the anticipated recovery in the office sector, our preference is still for retail. Our view (and international experience has borne this out) is that big regional malls are both more defensive and provide better rental growth over the long term compared to the office and industrial sectors.
Major transactions during the quarter include selling out of Pangbourne, reducing our exposure to Redefine and Liberty International, and further building our position in Growthpoint.
In summary we see reasonable opportunities within listed property currently, though volatility may remain high in the next few months. We believe stock-picking in the fund will become increasingly important, and will continue to use the asset allocation flexibility mandated within the fund.

Edwin Schultz
Portfolio Manager

Domestic listed property sold off heavily over the past quarter, declining by 19%. This wipes out all the gains of the year-todate, with the return of the index over this period now standing at -1.3%. This decline was driven by a rapid rise in bond rates (over 100 basis points for the quarter) and also a significant derating of listed property yields relative to bonds. Bonds returned -3.6% over the quarter, and -1.3% in the year to date. The Coronation Property Equity fund was also heavily impacted, with a decline of 16.2% over the quarter; however the return for the 12 months to end June is an attractive 18.1%.
The catalyst for the sell-off was a dramatic reduction in emerging market risk appetite, resultant depreciation of the rand, and the first 50 basis point increase in interest rates announced by the SA Reserve Bank.
We did caution against over-valuation in the domestic property market and the risk of interest rate increases in our previous commentary, and as such the fund was more conservatively positioned at the start of the quarter, with 22% invested outside domestic listed property stocks.
The fund benefited from the investment of 10% (maximum permissible level) in Liberty International, which returned 15% over the past quarter, and 33% in the year-to-date. This illustrates the huge diversification benefits of holding this exposure within an otherwise very homogeneous universe. Although Liberty International was actually down in pound terms over the quarter, the depreciation in the rand more than offset this.
Going forward we believe that the recent sell-off was probably overdone in many stocks, and as such provides a buying opportunity. Towards the end of the quarter we increased the domestic listed property exposure in the fund to 88% (from 78%), mainly through purchases in Growthpoint, but also Hospitality A units and Redefine. There is a risk that unit trust redemptions could lead to further declines in share prices, and we have thus left further capacity in the fund to increase exposure in this event. The fundamentals for listed property have not changed materially, and distribution growth forecasts remain good. We are expecting 9.8% and 9.3% for the next two years respectively. Clean forward yields on listed property close to 9% compare more favourably now to alternatives such as bonds and cash. We think there is value selectively in mostly the larger market cap stocks currently. Premiums to NAV now also look more realistic. The sector premium is now around 33%. Allowing for a 15% to 20% premium of listed over physical, and the fact that physical valuations are still lagging actual market transactions also by around 15% to 20% from our management interactions, this seems closer to reality.
The interest rate cycle has however turned in our opinion. To the extent that the market is expecting this to be an isolated increase, we believe this is an overly optimistic assessment. We are expecting two further 50bps increases over the next year. While this is a net negative, we don't believe it materially changes growth prospects for the sector. The benefits of refinancing debt will however slow, and it is important to assess the impact it has had on distribution growth historically and going forward. Fundamental prospects for the sector as a whole remain positive though.
An important point is that we still believe there are huge rating disparities within the listed universe, and that many lower quality, smaller companies are trading at yields much too close to the better quality larger counters. This partly explains why we have not further increased listed property exposure. The recent sell-off has exacerbated this, as much of the investor selling has been in the more liquid counters by necessity. The most attractive counter in our universe is currently Grayprop, where we are already at maximum exposure. We have hence also substantially increased our exposure to Growthpoint as already mentioned. We remain invested in Liberty International close to the maximum 10%, and the past two months of weaker currency and declining domestic property prices has demonstrated its attraction as a diversifier exactly when you need it. We believe there is still 5% upside in pound terms, and the dividend growth prospects are looking favourable. REIT conversion now seems highly likely, and should benefit the company in the long term. The development pipeline remains very attractive and a driver of growth in the long term.
In summary we believe that, although painful, the recent decline in share prices was probably a necessary and healthy correction. The fund is utilising its flexibility, and is in a good position to capitalise on further price declines if they happen. We are exposed to the quality larger counters, and think this reduces the risk within the fund. We do not think investors need to panic, and in fact panic in the market and resultant selling would create some attractive buying opportunities from current levels for patient investors.

Edwin Schultz
Portfolio Manager

Domestic listed property had a fantastic quarter, returning 21.9% and bringing the return for the past year to 73.6%. This return was driven by a significant re-rating of property relative to bond yields, and continued strong distribution growth being reported by the listed counters. Bonds returned a mediocre 1.5% over the quarter, bringing the return for the past year to 12.8%.

The Coronation Property Equity Fund also had a good quarter, returning 19%, and bringing the return over the past year to 53.6%.

The decision to increase the weighting in Liberty International to the maximum allowable amount in the previous quarter proved to be a good one. The company reported good results, with strong dividend and NAV growth in a fairly tough retail environment in the UK. In addition, a REIT environment with favourable conversion conditions was announced at the UK budget. The conditions to convert have proved less onerous than previously expected, especially regarding the conversion tax, which means that Liberty International management will be seriously considering the move to a tax-free REIT environment in the near future. The share increased by 18.5% in pound terms over the quarter, with rand strength against the pound offsetting some of this gain to bring the move to 15.7% in rand terms.

We have increased the level of caution in the fund, with 22% invested outside domestic listed property. During the quarter we reduced holdings in Sycom and Martprop, and sold out the fund holding in Capital Property Fund.

The holding in Foord Compass debentures was increased through a private placing during the quarter at attractive prices. We also participated in the recent Hospitality listing. Though very disappointed with our allocation during the placing, we have managed to build a meaningful stake in the Hospitality A units in the market subsequent to listing. We believe that these units are fundamentally very attractive, with the capital protection provided by the B units distribution being subordinated to the A unit distribution, and 5% distribution growth expected from the A units over the medium term.

We are retaining a more cautious positioning in the fund going forward, reflecting a belief that the good fundamentals expected from domestic listed property companies over the next three years are already fully discounted in share prices. In addition, further short-term interest rate declines are very unlikely, with an increase inevitable at some stage in the future. Distributions have benefited significantly from re-financing of fixes at current interest rate levels, and this benefit will also not be available indefinitely to boost distribution growth rates.
The focus within the fund will remain on the better quality listed companies, with good long-term distributions growth prospects.

Edwin Schultz
Portfolio Manager

Listed property continued to perform very well, with the SA Listed Property Index returning 11.4% over the past quarter, bringing the return for the calendar year to 50%.
The past quarter was a tale of two halves, with prices declining significantly during November, and subsequently rebounding significantly during December. The spread between listed property yields and bonds remained largely unchanged over the quarter, with good property returns thus being driven by declining bond rates and continued strong distribution growth. The All Bond Index returned 5% over the past quarter, and 10.8% over the year.
The fund showed a return of 7.4% over the past quarter, bringing the return for the calendar year to 36.7%.
During the sell-off in November we increased the exposure to domestic listed property to around 80% (from 73% at the end of the previous quarter), as a large seller in the market provided an opportunity to purchase large lines at attractive prices. Exposure was increased to our core holdings such as Grayprop, Sycom and ApexHi A, as well as Capital into declining prices. The holding in Emira was sold out, and the holding in Martprop further reduced.
We continue to believe that the yield differentials between the top quality properties and more secondary properties are too low, and are thus concentrating the fund in which we believe are the top quality property companies, with the best long-term growth prospects. A good example would be Grayprop, who have spent significantly on refurbishing and expanding some of their prime shopping centres recently, and will now be able to reap the benefits of improved trading and cost reductions going forward.
On the other hand we still believe that many of the property companies are overvalued at current levels, and will thus continue to utilise the flexibility of the fund mandate, with 20% of the fund currently invested outside domestic listed property shares.
While Liberty International has not performed well over the past quarter due to the strengthening rand, we continue to believe that it is a very attractive investment within the fund, and have increased exposure to the maximum allowable amount during the quarter. We will be getting further clarity on REIT conversion in the UK budget in the new year, which could be a positive development for listed property in the UK. In the mean time the development pipeline of Liberty International is progressing on track, and we are expecting good results to be released by the company early in the new quarter.
With cash rates being very low it is a constant challenge to optimise returns on cash holdings within the fund, and to this effect we participated in the recent Growthpoint securitisation. We believe it is a high quality securitisation with very low risk due to the quality of the assets underlying the investment. We are also investigating investments in other debenture structures to improve cash returns.

Edwin Schultz
Portfolio Manager