The SA Listed Property (SAPY) Index realised a total return of 4.4% in 2Q14. Year to date the return came to 6.3%, while on a 12-month trailing basis it was 6%. The one-year return can be explained by the dividend yield alone, with no capital growth over the period. In fact, the sector actually de-rated over the past year after accounting for growth in distributions.

Given the fairly muted total return for the sector over the past year and the consequent de-rating, at current price levels, the sector is trading at approximately a 7.5% dividend yield, well off its highest price levels when it traded at the low yield of 6% (lower yields mean higher property prices). These levels imply a lower risk of short-term capital losses and a higher probability of long-term inflation-beating returns. Corporate activity continues to be highly prevalent in the sector, but the theme is now consolidation as opposed to listings, which were the flavour of the day one to two years ago when listed property prices were elevated. But naturally, with current lower listed property prices, we're seeing material consolidation in the sector via acquisitions and mergers.

Index changes and performance
Trading in the property indices during the last quarter was higher than normal due to corporate actions in Growthpoint (shares in issue increase), Fortress (rights issue) and the Acucap/Sycom merger, which all had a negative influence on performance. The churn during the quarterly re-balance (2.1%) was also somewhat above the norm. All of these factors contributed to your portfolio underperforming the SAPY benchmark by about 9 basis points.

Outlook
We continue to re-iterate that long-term investors should be less concerned with short-term movements in capital values, on the back of bond yield movements, and more concerned with their income yield, combined with the defensiveness and potential growth in income.

We highlight that:

1) Following the falls from its peak of <6% yields, the sector is offering investors an average forward yield of about 7.5%, which is, in itself, a real yield (dividend yield alone exceeds inflation expectations).

2) Property is a good inflation hedge due to contractual rental escalations in line with inflation, sometimes higher, which pass through to inflation-like income growth. For the long-term investor with a multi-year investment horizon, and whose primary investment return objective is to beat inflation and cash, the probability of achieving a real long-term annual total return from current listed property levels is high in our view. Property offers good diversification from typical equities. The volatility alluded to above could actually provide new or existing investors with attractive buying levels into the sector. For example, within 1Q14, the sector traded at more than an 8% forward yield.

Market review

The SA Listed Property Index (SAPY) slipped 1.3% during the third quarter of 2013, continuing the weak performance that commenced in the second quarter of 2013 and ending a period of strong absolute performance in the period since the beginning of 2012 (>45% total return during that period). Year-to-date, the total return delivered by listed property has been 7.3%.

What the moderately negative third quarter performance neglects to show is the high degree of volatility experienced during the quarter within the listed property sector. At one point, the sector was down about 12% from its second quarter closing level, before recovering significantly in September to end the quarter just 1.3% down. In terms of yields, the sector de-rated within the quarter from an average yield of less than 6% at its highs in 2013 back to very close to 8% at one point, which represented a good buying opportunity in our view.

This sector's volatility was driven by large moves in local long government bond yields. This is in line with our previous commentaries in which we highlighted the strong positive correlation between local bonds and local listed property. At the start of the quarter bond yields spiked about 75 basis points (bps), driving the listed property sector to its intra-quarter trough. But bond yields subsequently fell back to end the quarter in line with quarter two's closing levels, driving the recovery in listed property in September.

What SIM did

Given their higher liquidity, low yields, and greater levels of foreign ownership, the larger cap listed property shares were hardest hit during the sell-off. Having positioned the SIM Property Fund to benefit from this because we did not consider the sector cheap, the Fund was, and still is, underweight these larger cap shares, and overweight the higher yielding, less liquid, less foreign owned shares, which we expected to be less vulnerable in event of a sell-off. The strategy worked to good effect, with the SIM Property Fund adding close to 70bps during the quarter relative to the sector average total return and close to 90bps over the past 12 months.

We thus used the periods of relative weakness of large-caps relative to small/mid-caps to close some of these bets, particularly buying Growthpoint quite aggressively. It was one of the bigger underweights, which underperformed the Index and contributed positively to the Fund's relative performance. This was funded by selling Emira in particular (one of the bigger overweights which outperformed the Index and hence contributed positively to Fund relative performance).

We also continued to add to our positions in NEPI and Delta Property Fund, two shares we highlighted in our first quarter commentary and continued adding to in the second quarter as well.

Outlook

In the near term investors may experience continued short-term volatility in listed property on the back of our local bond yield movements, which are, in turn, heavily influenced by foreign investor sentiment and flows. However, for long-term investors less concerned with short-term capital fluctuations on the back of bond yield movements and more concerned with their income yield it's worth considering the more concerned with their income yield it's worth considering the following: 1) After coming off its peak, the sector is again offering investors an average forward yield of about 7%, which is, in itself, a real yield (dividend yield alone exceeds inflation expectations). 2) Property is a good inflation hedge due to contractual rental escalations that are in line, and sometimes higher, than inflation, which translates into inflation-like growth in income.

For a long-term investor with a multi-year investment horizon, the probability of achieving a real total return (above CPI) from current listed property levels is high in our view, especially if the current volatility being experienced is used to the investors advantage by adding to investments if there are material capital value dips as a result of spiking bond yields.

For example, during the third quarter, bond yields spiked and listed property de-rated to close to an 8% forward yield. This represented a good buying opportunity for the long-term investor, certainly relative to earning cash returns, which barely compensate for inflation and are not creating wealth for investors in real terms. At those depressed listed property price levels intraquarter, the distribution yield alone, before even allowing for expected growth in the distributions, compensated investors with about 200bps in excess of expected inflation.

Market Review

The SA Listed Property Index (SAPY) slipped 0.4% during the second quarter of the year, finally curtailing the strong absolute performance since the beginning of 2012 when it delivered a total return of more than45%. Year to date, listed property's total return is 8.8%. Despite the weak absolute return for the quarter, relative to general equity (SWIX), the listed property total return was still flat and up 6% year to date. What the sideways move in the sector doesn't show is the high degree of volatility experienced during the quarter. From its peak reached in April listed property sold off by 20% before recovering somewhat towards quarter end. Alternatively, in terms of yields, the sector de-rated during the quarter from an average yield of less than 6% back to more than 7% at one point, eroding one year's gain in the space of a month.

The volatility was driven by large moves in local government long bond yields. This is in line with our previous commentaries where we highlighted the strong positive correlation between local bonds and local listed property. At the start of the quarter, we saw a further initial drop in bond yields of 80 basis points (bps), which drove the listed property sector to its peak. But, thereafter, bond yields spiked 160bps in the space of one month from these depressed yields, prompting the sell off in listed property.

We highlighted this scenario as a short-term risk in our previous commentaries. We warned investors firstly not to expect a repeat of the lofty 35% total return of 2012, as it was primarily a result of a rerating (>100bps decline in bond and listed property yields in 2012, unlikely to repeat from already very low levels), and that, secondly, the odds were in fact weighted towards a nearer term negative contribution from derating i.e. a reversal or correction of some of these gains (via bond and listed property yields kicking up again from very depressed i.e. expensive levels)

What SIM did

Given their higher liquidity, low yields and greater levels of foreign ownership, the larger cap listed property shares were hardest hit during the sell off. Having positioned the SIM Property Fund in line with our view that the sector was not cheap, the Fund was, and still is, underweight the larger cap shares that have run the hardest and overweight the higher yielding, less liquid, less foreign-owned shares, which we believed would be less vulnerable in event of a sell off. The strategy worked to a small extent, with the SIM Property Fund adding close to 30bps during the quarter relative to the sector average total return.

We used the periods of relative weakness in large-caps relative to small/mid-caps to close some of these bets, particularly buying Growthpoint quite aggressively as is sold down more than 20% off its highs at some points and given that it is the largest constituent of the sector and our biggest underweight.

We also continued to add to our positions in NEPI and Delta Property Fund, two shares that we highlighted in our first quarter commentary when we first invested in these.

Outlook

In the near term, investors may experience continued short-term volatility in listed property levels on the back of local bond yield movements, which are, in turn, heavily influenced by foreign investor flows. However, for long-term investors, who should be less concerned with short-term movements in capital values on the back of bond yield movements and more concerned with their income yield, defensiveness and potential growth in that income, we highlight that: 1) Following the falls from its peak, the sector is again offering investors an average forward yield of about.7%, which is, in itself, a real yield (dividend yield alone exceeds inflation expectations). 2) Property is a good inflation hedge due to contractual rental escalations in the inflation range, sometimes higher, which translate into inflation-like growth in income.

Thus long-term investors at these price levels who have a multiyear investment horizon have a very high probability of achieving real total returns a year. (including income yield + income growth) that exceed CPI by a reasonable margin, with moderate risk. However, the short term has been, and may continue to be, marred by a high degree of capital value volatility and possibly even further capital de-rating given bond yield volatility and foreign investor flows.

Nevertheless, a considered long-term investor will realise that getting the timing perfect, investing at the exact bottom of the market and thus avoiding any potential short term (unrealised) losses, is impossible. He will also realise that over a very longterm investment horizon (multi-year or even multi-decade), the odds of achieving the above mentioned real total returns a year. approaches near certainty because capital re-rating or de-rating, driven by yield changes, should ultimately be insignificant, leaving the investor's total return profile dominated by income yield and income growth.