Whereas listed property yields followed bond yields with a lagged effect and some trepidation during the first part of the quarter, the strong relationship between the two asset classes returned during September. For the first part of the quarter, local bond yields were heavily influenced by yields in the US which gained substantially despite the downgrade of US sovereign debt by Standard and Poor's. In addition, ongoing concerns over both US and global growth, coupled with continuing concerns regarding European debt, kept bond yields low as a flight to safety followed despite the upward trend in inflation. With risk aversion returning to financial markets, the weakness in the rand during September has led to local bond yields moving out substantially. The strength of the relationship between local and US bond yields, which we have experienced since the start of the year, has weakened substantially with US yields retaining its safe haven status on growth concerns. The total return of 2.2% delivered by the sector for the quarter masks the underlying volatility in yields and lack of direction from the direct property market. Our sense is that the sector continues to trade on yield momentum rather than the underlying property market fundamentals. With a relatively disappointing results season and cautious to negative forward guidance from management teams, it lets us to believe that investors in search of yield along with foreigners continue to drive the sector forward.

The fund performed in line with the SA Listed Property Index (SAPY) for the quarter, and remains top quartile over the 12 and 36-month period. Volatility and large discrepancies persist in the quarterly performance of the illiquid counters, while those investors seeking yield are chasing the larger more liquid ones. Results released during the quarter led the performance of individual companies on both ends of the return spectrum. Resilient, Fortress A&B, Growthpoint, Acucap, Capital and Fountainhead delivered strong performances, while tightly held counters like Octodec and Premium struggled, with weaker results-driven performance from Emira and Hospitality. Positive performance contributions came from our relative exposure to Fortress, Resilient, Nepi, Emira, Acucap and Capital. Our relative exposure to SA Corporate, Hyprop and Hospitality A detracted from return. In addition, the exposure to Capital Shopping Centres and Capital & Counties also detracted from relative performance as UK property came under pressure in light of an uncertain UK economic environment. We remain comfortable with our exposure to these two companies and continue to closely interact with management to ascertain the operating risks. The integrity of the A&B listing structure is being tested at present with the trading statements of Fortress and Hospitality at the opposite end of the spectrum illustrating the merit of choosing one's own risk profile. We remain comfortable with our exposure to the three A unit structures listed within the sector and have the conviction that there is sufficient future earnings growth to ensure the lower of CPI or 5% distribution growth as per the A unit structure. We continue to reduce the fund's exposure to Foord when volumes allow it. In addition, we decreased the exposure to Acucap and Redefine on a yield relative basis and sold out of SA Corporate due to a lack of visibility in distribution growth recovery. With portfolio and management quality again starting to become much more important in relative yield movements we increased our exposure to Growthpoint and Capital. We also initiated exposure to Rebosis and reinstated to Vukile as both seem attractive on relative yield and growth prospects. This decision followed meetings with both management teams in which we gained assurance on the certainty of the respective earnings streams. Both Vunani Property Income Fund and Dipula Income Fund listed during the month. Albeit small listings, we participated in both pre-listing capital raisings during the period, both at beneficial yield discounts relative to that of the sector. Vunani listed at 9.8% with a mostly office exposed underlying portfolio. We participated as the higher yield came with a relative clean portfolio, and the average portfolio rent comparing favourably with current market rentals. In addition, value adding development opportunities are very likely in the short term at the Vodacom site in Sandton, as it will make sense for both tenant and landlord. Dipula in turn listed with an A & B unit structure and initial listing yields of 9.25% and 10.73%. The security in the A income stream at listing was relatively intact despite a portfolio with a small average property size, again creating a favourable annuity type investment with yield rerating potential.

With nearly two thirds of the sector reporting during the quarter, it served as barometer for the current state of listed property. The sector delivered a weighted average distribution growth of 6.4% for the six-month period to end June 2011. The results were rather polarized with Capital, Resilient, Fortress and Growthpoint all delivering distribution growth north of 8% for the period (year-onyear). On the other side of the spectrum Emira and Hyprop came in between 3% - 4%, SA Corporate at 0.8% and Hospitality at a combined -25.6%. The results pointed to the following:
- Weaker portfolios remain under pressure across all three subsectors
- From a sector point of view select industrial is the strongest, then retail and followed by office
- Sector weighted average vacancy has been coming down and at 6.5% is still below the historical average of 7.7%
- This has come at the expense of operating cost ratios with higher broker commissions and tenant installations being offered to attract tenants
- Operating cost ratios are also increasing due to higher repair and maintenance spend to ensure that tenants will actually renew leases - many leases have moved to rolling monthly or 12-monthly
- Landlords still recoup most electricity costs and between 60% and 80% of rates and taxes, but it is putting pressure on reversions
- Companies are all diversifying away from bank funding and are investigating short or medium-term paper funding alternatives
- Funding margins remain under pressure although many are attempting to utilize the current low rates to either refinance or fix interest rates. What has been clear this past quarter is the way different management teams react to the ongoing stressful operating environment - the rated management teams are coming through strongly and one can see this in the distribution growth delivered and prospects . Pro-active management teams are the clear stand-outs. Going forward these companies will be the ones being supported by investors with continued cautiousness towards unproven management teams. We will thus continue to see the polarization within the sector with the overall sector performance not necessarily driven by fundamentals. Yield momentum support should remain in the sector with dovish comments from the most recent MPC meeting pointing to a potential likelihood of an interest rate cut should growth concerns outweigh inflation concerns. Property market fundamentals remain weak, but this seems not to be a factor in the current sector trading trends. Stock selection continues to be of highest importance in an uncertain market where relative value disparity stubbornly persists between the individual companies. Portfolio manager Anton de Goede

The listed property sector's total return of 5.0% for the past quarter disguises very volatile intra-period trading conditions. The push-pull momentum factor has remained, with many generalists still entering the sector as a yield play compared to the specialists who are not yet finding solace in the underlying direct market. While some inflationary risk could still impact local bond yields, it seems as though the traders are just focusing on the trends being set by US bonds. Not only is our bond market being supported by a similar trading pattern to US bonds, but also a seemingly consistent shortterm view on inflation. Results releases since the previous quarter did not provide any comfort with regards to the domestic commercial property operating environment. While both Redefine and Fountainhead are dealing with the dilutionary impact of either operations integration or development activity, Vukile delivered the stand out performance with distribution growth of 9% for the 2011 financial year. In turn, Sycom delivered negative distribution growth for its reporting period. This was mainly due to an increase in vacancy numbers as a result of leases not being renewed, although the prevalence of new office leases being signed at lower rental levels continued. Sycom's performance was the biggest drag on Acucap's distribution growth of 6.3% as 15% of its distributable earnings are attributable to its holding in Sycom. Operating cost ratios are under pressure due to higher-than-inflation increases in municipal charges and electricity, with municipal valuation back-charges another recent sting in the tail.

The fund outperformed the SA Listed Property Index for the quarter and remains top quartile for the 12-month period. The uncertainty in the sector is leading to much volatility among those stocks with limited liquidity. The positive performance contributions came from our overweight positions in Hospitality A, Redefine and Acucap as well as our exposure to the non-benchmark constituents Nepi, Capital Shopping Centers (CSC) and Capital & Counties (CapCo). In addition our limited exposure to Emira, SA Corporate, Premium and Octodec assisted in achieving outperformance. Relative value detraction came mostly from our underweight positions in Growthpoint, Sycom and Fountainhead and exposure to Fortress A. In terms of relative positioning we increased our exposure to Capital and Hyprop from cash as well as reduced positions in Growthpoint, Emira and SA Corporate. This was done to selectively benefit from the recovery in industrial and retail property. Industrial properties linked to distribution and warehousing seems to be the strongest subsector at present as many retailers are positioning their logistics for a potential Walmart entry. Furthermore, two retail subsectors on opposing sides of the spectrum - regional and commuter - remain the most defensive, while also rebounding the quickest.

We participated in various capital raisings during the period, all at beneficial discounts relative to that of the sector. One of two new listings was the Investec Property Fund. We participated in the pre-listing capital raising at a yield of 9.5%. The fund has an industrial and office bias with the potential to grow its existing 29 properties through utilising the relationship with its 50% shareholder, Investec. We did not participate in the listing of Rebosis Property Fund as our view was that the risk/reward ratio from the listing yield of 8.6% did not reflect the East London retail concentration risk in the portfolio. Further to the two new listings, Fountainhead, Nepi and CapCo also raised capital and we participated in all three. We were fortunate to secure participation in the placement of Capco from which we already benefitted as its share price has since rebounded strongly from discounted pricing levels of 162p. In addition, the cash drag should be limited as the acquisition of five properties for £68 million from Derwent London shortly followed the capital raising. As part of the raising an interim management statement (IMS) was published, which pointed to continued positive momentum within the Covent Garden repositioning. Important for the redevelopment of Earls Court is that the mayor's Planning Inspectorate has officially reported that the redevelopment offers a sound basis for planning, subsequent to which the planning application for the redevelopment has been submitted. CSC also published an IMS. It is currently difficult to read a very tough UK retail environment. It seems as though CSC has lost a bit of momentum since year-end, although the overall trajectory is still positive for the long term positioning of the portfolio/tenanting once the UK retail market starts sending stronger signals. Trading remains very volatile with Zone A rentals being flat and no pattern with regards to which retailers are going into administration. Many retailers are also announcing planned store closures, but luckily CSC seems strongly positioned to keep trading stores or replace tenants. Fortunately CSC has not seen any decrease in the demand for space in the UK market from US retailers, or from stronger performing UK retailers who are expanding space to create flagship stores.

Hospitality Property Fund issued a trading statement which guided to the fund's combined A and B distribution for the 6 months to June 2011 to be at least 25% lower than the previous year. The A unit's growth, through which we hold most of our exposure, will not be impacted by this, while the B unit's growth will be at least 60% lower. For the distribution growth in the A unit to be negatively impacted in the immediate future, the entire company's distributable earnings would need to go back 30% in the 2012 financial year. In total, distributable earnings should be 12% lower in the current financial year based on the trading statement, and taking the World Cup base (being contracted to Tourvest rather than Match and thus having a solid strong base in June 2010) of the 2010 financial year into account, the state in the industry needs to deteriorate substantially from its current depressed base before such a earnings level would be reached. The South African operating environment remains very sticky. After an improved start to the year management teams have picked up a deteriorating trend in the second quarter. Retaining clients, especially in the office sector, remain difficult. Potential tenants are becoming more astute in negotiations with a greater demand for tenant allowances. This is placing downward pressure on office rentals in particular, with negative reversions seemingly becoming the norm rather than the exception. Industrial letting remains the strongest and most defensive, followed by retail. However, in contrast to national retailers, line shop tenants continue to find trading conditions difficult despite the continued improvement in retail sales growth. Led by electricity, an average increase in administered prices of between 15% and 20% for the first six months of the year is putting further pressure on both landlord and tenant, making rental negotiations more difficult. In addition, service delivery standards are ostensibly decreasing, in many instances resulting in additional cost layers for landlords. For the listed sector we expect the environment to remain volatile and for yields to closely follow bonds for at least the next few months into August when the next big wave of results releases will be announced.


Portfolio manager
Anton de Goede

Listed property started 2011 with a firing power, similar to that with which it ended 2010. This early burst was boosted by an initial recovery in bond yields. However, as the quarter progressed, the weaker bond market took its toll on the sector. This placed upward pressure on yields with the sector's clean forward yield moving from 8.2% to 9.0% by mid March. At that point, the sector delivered a total return of -7.1%, but rebounded strongly with 5.3% over the last two weeks of March to deliver a total return of -2.2% for the quarter. This strong bounce can probably be ascribed to positive momentum experienced in the sector after it had gone ex-div towards mid-month as investors began to see some signs of favourable relative value compared to the negative returns of the first few weeks of the year. The resultant clean forward yield for the sector at quarter-end was 8.6%.

Besides the negative impact of the bond market, the sector lagged on largely disappointing results released over the past two months. The majority of distribution growth reported was either as management had guided, or 1% to 2% lower than expected. Average distribution growth came in at 7.5%, with only Hyprop and Growthpoint marginally surprising on the upside. This is in direct contrast to the previous 12 months during which the sector experienced a positive burst in share price movement. At that time management teams delivered guidance statements that exhibited a more positive stance. This time around guidance statements are much more muted, reflecting the very challenging operating environment.

The fund outperformed the SA Listed Property Index (SAPY) for the quarter. The positive performance contributions came from our overweight positions in Fortress A, Hospitality A, Pangbourne and Acucap as well as our exposure to the nonbenchmark constituents Nepi, Capital Shopping Centers (CSC), Capital & Counties (CapCo) and Foord Compass. Relative value detraction came mostly from our underweight positions in SA Corporate, Octodec and Premium as well as exposure to Redefine and Resilient. In addition to our relative stock selection, which can be viewed as a bit more defensive, the cash exposure also assisted to achieve outperformance in this quarter. In terms of relative positioning we increased our exposure to Redefine, Fortress A, Capital as well as CSC, and initiated exposure to SA Corporate after its full-year 2010 results release. This was funded from our cash position as well as our decreased exposure to Acucap, Emira and Resilient. Most of the additional Capital exposure came about due to the holding we had in Pangbourne and was achieved through the take-over of Pangbourne by Capital for shares and the subsequent delisting of Pangbourne.

The big news in the listed property sector thus far in 2011 was the 50% acquisition of the V&A Waterfront by Growthpoint (as a 50/50 JV partner with the PIC). Although the acquisition yield of 7.2% seems high compared to the acquisition yield of the previous owner (mooted to be between 5% and 6% at the time), clarification from management showed that this is the yield on the income producing assets only, which is probably at a premium to the market. But there is no doubt that further value can be added on this yield through the development bulk acquired. CSC and Capco have both delivered full-year results during the past quarter. In terms of CSC, momentum in both positive capital returns and improved letting continued. Despite the strong price movement experienced recently, further price upside still exists as valuation yields have the potential to move lower. Further upside potential may come from synergies with the management team of the recently acquired Trafford Centre as they capitalise on active management opportunities throughout the portfolio. Capco has proven that there is more to this group than meets the eye in terms of value creation. Not only is management successfully transforming Covent Garden into one of London's foremost retail and leisure destinations, but is also increasing medium-term rental revenue prospects. In addition to Covent Garden, momentum is also building for the other large repositioning project within the portfolio, namely Earl's Court and Olympia.

The big question for the listed property sector is whether the movement over the last month was a missed entry opportunity after the weak first two months of the year? It is interesting that this strong rebound occurred with no fundamental change in the underlying direct market after the largely disappointing results released in the past two months. Over the last few months it has become clear that, from a direct market point of view, the retail sector has started to move into a recovery phase, but the office and industrial sectors continue to lag. Municipal and electricity tariff increases are placing pressure across the entire property sector, from tenant to landlord, while service delivery standards are ostensibly decreasing, in many instances resulting in additional cost layers for landlords.

Anecdotal evidence continues to point to the presence of many generalists within the sector, using it as short-term yield play, many of which entered forcefully when the sector touched a 9% forward yield early March. We continue to expect the sector's volatility to remain heightened due to this presence as well as due to market speculation of the next move and timing in interest rates, especially with the weaker than expected February PPI number. Operationally it is still tough and despite the higher than expected SAPOA/IPD total return numbers of 13.3% for 2010, our sense is that the direct market is still in for a few months of strain from an income perspective. Taking all of this into account, the fund remains defensively positioned with more retail than office and industrial exposure as well as maintaining the cash position between 4% and 5% to utilise capital raisings, new listings and yield spikes. In addition, we continue to maintain our exposure to A-unit structures and some rand hedge exposure while focusing on stock selection where the relative yield and distribution growth prospects of each individual stock are the key determinant of portfolio inclusion.

Portfolio manager
Anton de Goede Client

The listed property sector continued to exhibit its positive momentum of the first three quarters of 2010 in the final quarter of the year. As in the third quarter, the sector exhibited its hybrid risk and return characteristics of being a part fixed income, part equity asset class. Despite the local bond market being under some pressure in the fourth quarter, the positive momentum of the equity market eventually pulled the sector through to a positive total return of 3.1%. Positive sentiment from another 50bps interest rate cut and potential corporate action kept more speculators in the sector. With many of the macro-economic data announcements well anticipated by the market, the sector remained fairly stable on the yield basis, with a weighted average forward yield of 8.2% at quarter end. This resulted in a marginal rerating relative to the rolling 10-year bond.

The fund performed in line with the SA Listed Property Index (SAPY) for the quarter. The positive performance contributions came from our overweight positions in Resilient and Emira as well as our exposure to the non-benchmark constituents Capital Shopping Centers (CSC), Capital & Counties (CapCo) and Foord Compass. Relative value detraction came mostly from our underweight positions in Growthpoint, Vukile and Hyprop and exposure to Hospitality A and Fortress A. We remain comfortable with our exposure to these two listings as we continue to believe that the market is not fully appreciating the benefits of the A-unit structure. In a rising market, as was experienced this past quarter, any cash exposure also detracts. We however remain comfortable with our current cash exposure.

We have increased our exposure to Redefine, Growthpoint, Hyprop and Fountainhead during the past three months. This was funded from our cash position as well as our decreased exposure to Acucap. The rationale for all these transactions was relative value related, mostly on a relative yield basis, although Hyprop and Growthpoint could surprise on the upside with its forward distribution growth prospects at the next round of results announcements. In addition, we participated in a discounted bookbuild in a surprise capital raising by CSC as part of the potential acquisition of the Trafford Centre in Manchester. The Trafford Centre is the sixth-largest shopping centre in the UK (approximately 140 000m² in size). If successful it will become 25% of CSC's assets and reduces the dependency on major assets like Lakeside, Metro and Braehead. Although the bookbuild has been successfully concluded, the company is entangled in a public stand-off with the United States-based shareholder Simon Property Group on the merits of the acquisition as well as a potential take-over bid by Simon for CSC. The acquisition enables CSC to dominate the regional shopping centre market in Manchester, where it already owns the city's other major shopping centre Arndale, as it does in Newcastle.

We continue to remain comfortable about our exposure to nonbenchmark constituents CapCo and CSC. Both released interim management statements during the quarter. The statements entailed continued positive news from both companies, with letting successes across the board. Within the CSC statement an emphasis was placed on organic growth, positioning its portfolio as not being ex-growth in the UK due to the austerity measures. In turn, CapCo confirmed that it has been recognised by the two local boroughs involved in the Earls Court redevelopment and a statement of common ground between them and CapCo has been concluded. Management will also take a more hands-on roll with the management of the Great Capital Partnership, focusing on retail and residential opportunities within the partnership.

Judging from management interaction following the final round of results releases for calendar year 2010, it became evident that offices continue to bear the brunt of weak tenant demand. There seems little impetus for this to improve in the short term. Tenants seem to replace existing leases, when they expire, with much shorter-term leases as economic and operating uncertainty makes it difficult to commit to longer time periods. In addition, landlords are willing to accept lower rentals than expiry rental even on these shorter-term leases to ensure tenant continuity as not to incur tenant installation costs or broker commissions. Operating cost ratios are under pressure due to higher than inflation increases in municipal charges and electricity, with municipal valuation back charges being another recent sting in the tail. The retail sector is leading the occupational market recovery, in general showing better recovery in vacancies and upside in lease renewals close to historical lease escalation rates. Pockets of industrial property are coming through strongly - mostly big logistic or distribution spaces - while mini and midi units are still seeing some downside. In terms of gearing, companies are still riding the coat tails of the lower interest rate cycle by keeping as much debt as possible variable, as fixes unwind and are now attempting to fix at the low point of the cycle depending on the next interest rate move.

Generalists seem to increasingly enter the sector using listed property as a short-term bond play with the opinion that the sector's anticipated distribution growth prospects should buffer it against a potential turn in bond yields. The sector's volatility will probably increase as evidence emerges on the next move and timing in interest rates. At current levels the sector offers limited value relative to bonds on a risk/reward basis taking the current anticipated 12-month forward distribution growth into account. Although the growth prospects are improving compared to that of the last 12 months and remains above inflation prospects, the price the market is prepared to pay for this growth seems to offer limited scope for a further re-rating relative to bonds.

Portfolio manager Anton de Goede