Increased geopolitical risk and less certainty from central banks about the future direction of interest rates helped shape the environment for global financial markets during August. North Korea continued to press ahead with missile tests despite global condemnation following the firing of a missile over Japan during August. Political tension in Northeast Asia has been escalating throughout 2017 and now presents a substantial risk to the stability of global financial markets. The US Federal Reserve (the Fed) now appears divided about the pace of future interest rate hikes in the US following the release of the minutes from their July policy meeting. While there is some evidence that the accommodative monetary stance is stimulating economic growth, inflation has failed to reach 2% and isn’t expected to breach that mark any time soon. This may allow the Fed to pause for longer before the next interest rate hike.

While global bond yields fell in response to increased demand for safe-haven assets like gold and sovereign debt, South African bond yields were little changed during August after President Jacob Zuma survived another vote of no confidence. At the same time, the bail-out and continued funding needs of state-owned enterprises (SOEs), together with a substantial shortfall in tax revenue are likely to lead to a material increase in the government’s borrowing requirements in the short and medium term. South Africa’s listed property sector posted a modest gain in August, despite several companies warning that property fundamentals had deteriorated since the late-night cabinet reshuffle in August. It is becoming increasingly difficult for companies to forecast distribution growth due to rising vacancies, increased incentivisation to retain or attract tenants and the direction of official interest rates.

During August, the Nedgroup Investments Property Fund declined by 1.3%, underperforming the FTSE/JSE SA Listed Property (SAPY) Index. Over the past 12 months, the fund has returned 9.5%, while the SAPY Index has returned 9.4%. The relative underperformance in August can be attributed to the fund’s higher exposure to domestically-focussed listed property companies where recent selling pressure has pushed prices lower and initial income yields higher.

While we acknowledge that property fundamentals in South Africa have deteriorated throughout 2017 and distribution growth forecasts have been lowered for 2017 and 2018, the current forward yields on many of the domestically-focussed listed property companies are extremely attractive when compared to longterm historical averages as well as the yield on government’s benchmark R186 bond. The combination of a high initial income yield in excess of 10% and inflation-beating distribution growth in the medium and long term should deliver strong investment returns for long-term investors.

The fund is currently offering investors an initial income yield (before fees) of 10.6% and distribution growth of approximately 6.2% per annum over the next three years. The forward yield on the portfolio is significantly higher than the 6.9% forward yield on the SAPY Index and 8.5% yield on the R186 bond. The fund continues to invest predominantly in small and mid-sized, domestically-focussed listed property companies. For the most part, these companies continue to trade at discounts to net asset value due to a lack of meaningful institutional support. This provides a significant opportunity for smaller investors or institutional investors that intentionally limit their absolute exposure to listed property (like Bridge Fund Managers). These property businesses offer investors attractive initial income yields above the yields on long-dated government bonds and growth in distributions that are forecast to exceed inflation over the short and medium term, despite the increased political uncertainty.