Investment Manager Commentary
Grindrod Asset Management

The possibility of a sovereign rating downgrade by Standard & Poor’s in June caused the rand to weaken and South African bond yields to rise. The share prices of most listed property companies declined during May as the forward yield on the sector rose more or less in line with bond yields. As a result, the South African Listed Property (SAPY) index declined by 3.5% in May, but is still up 8.4% in 2016. The losses incurred in May were predominantly in the larger, more liquid companies that have been trading at premiums to net asset value for some time now and remain extremely vulnerable to a change in investor sentiment. During May, the Nedgroup Investments Property Fund produced a positive return of 0.3% due to its higher exposure to the smaller listed property companies trading at large discounts to net asset value and offering investors extremely attractive initial income yields.

A number of the companies in the Fund reported very pleasing results during May, including Delta Property Fund, which produced 8% distribution growth and forecast a similar level of growth in 2017, despite offering investors an initial income yield in excess of 15% at the time the results were announced. Equites Property Fund, a focussed industrial REIT in South Africa and a recent addition to the fund, produced distribution growth in excess of 18% and announced a joint-venture with Attacq and the purchase of a Tesco distribution centre in Hinckley, England valued at £28 million (around R600 million). The company is forecasting distribution growth of between 10% and 12% in 2017.

The fund’s allocation to offshore markets in the UK, Australia and eastern and central Europe continues to grow as many of the companies in which the fund invests look for opportunities outside South Africa. Importantly, the prices being paid for these opportunities is far lower than investing in focussed offshore property funds listed on the JSE that, for the most part, are trading at steep premiums to net asset value and very low initial income yields. While the pace at which these companies are moving offshore is slow but steady, the value creation in the long term is likely to be significant, given the attractive entry yields for new investors today. Based on current announcements and existing offshore exposure in the fund, including NEPI, the fund’s offshore exposure is expected to top 20% by the end of the current calendar year. With most companies in the fund actively pursuing offshore opportunities, that allocation is likely to grow, but not at the expense of the initial income yield and future distribution growth. Simply buying offshore focussed companies on the JSE today would significantly dilute both the initial income yield and future distribution growth prospects.

The Nedgroup Investments Property Fund is currently offering investors an initial income yield (before fees) of 10.3% and distribution growth in excess of 15% in 2016 and 10% in 2017.

January was characterised by heightened levels of volatility as investors became increasingly worried about the slowdown in global economic activity. The oil price tumbled below $30/barrel as supply continues to outstrip demand. The US Federal Reserve opted to leave interest rates unchanged at their January policy meeting, while the Bank of Japan introduced negative interest rates to encourage bank lending and consumer spending. The South African Reserve Bank responded to the threat of higher inflation posed by the sharp fall in the value of the rand by raising official interest rates by 0.5%. The move was widely expected by economists and had little impact on domestic financial markets. Although there was a recovery in prices in the final week of the month, South Africa's listed property market declined by 3% in January, although the South African-focussed property companies significantly underperformed those with large offshore exposure.

The Nedgroup Investments Property Fund declined by 4.9% in January after particularly large drops in the prices of Dipula B (-14.3%), Investec Property Fund (-9.7%) and Texton (-8.1%) on extremely low volume. Investors have become increasingly nervous about the prospects for listed property in South Africa given the weak and uncertain economic backdrop and the prospect of higher official interest rates. This led to some rotation out of listed property companies with high exposure to South Africa and into companies with offshore exposure, exacerbating the relative value gap that existed prior to the sharp devaluation in the rand. The two-tiered market in South Africa's listed property sector continues to offer investors the opportunity to construct a welldiversified portfolio of securities with an initial income yield in excess of 10% and growth in that income stream in excess of inflation over the mediumterm, despite the mounting headwinds. Importantly, these companies are also trading at large discounts to the underlying value of their property portfolios and over the past 18 months have been diversifying geographically with investments in Australia, Europe and the United Kingdom.

The fund continues to provide investors with a high level of initial income, as well as opportunities for inflation-hedged income and capital growth over the medium and long term. The current one year forward yield on the Nedgroup Investments Property Fund is 10.7% and distributions are expected to grow by 9.5% per annum over the next three years. The one-year forward yield is substantially higher than the one-year forward yield on the FTSE/JSE SA Listed Property (SAPY) index, which is currently just 6.5%, although distribution growth from the SAPY index is currently forecast at 12.9% per annum, with most of that growth a function of offshore exposure (which should support strong distribution growth in 2016) and recent corporate action.