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Property ETFs are not a substitute for active funds

A number of open-ended direct commercial property funds have stopped investors taking out their money following a wave of redemption requests, which intensified following the vote for Brexit. If you are looking round for alternatives, there are a number of exchange traded funds (ETFs) which invest in property, and as these funds are stock market listed they are easier to sell. However, they will not necessarily fulfil the same function in your portfolio.

Like closed-ended funds such as investment trusts, ETFs are priced and traded throughout the day on a secondary exchange. Unlike with open-ended active funds, if investors want to sell their shares they can trade them on the secondary market, and the ETF does not have to sell assets to redeem investors.

Therfore, investors in property ETFs did not suffer the same treatment as investors in some open-ended funds in the wake of the Brexit vote, who cannot take out their money or only exit if they pay a hefty fee.

A number of open-ended commercial property funds are having to sell their large, illiquid property assets to give investors back their cash, and this can take some time hence the suspension in redemptions.

ETFs also have an advantage over property investment trusts: they do not swing out to wide discounts to net asset value (NAV) due to their structure, and because they can create or redeem more shares.

Property ETFs offer exposure to an illiquid asset class with healthy income streams at a low cost without many of the problems active property funds encounter. But property ETFs are a very different proposition to active property funds and will behave in a different way, so are not necessarily a substitute for active funds.


Similarities and differences

Active funds can invest in property directly by purchasing physical buildings, indirectly via holdings in listed property companies, or a mixture of both (see Big Theme on p40 for more on this). ETFs only get exposure indirectly via shares in listed property companies such as real estate investment trusts (Reits). This means property ETFs are invested in companies whose shares are liable to large market swings as the assets they hold are buffeted by the stock market. Physical bricks and mortar assets held in a direct property fund over the long-term tend to be less volatile.

For example, iShares UK Property UCITS ETF (IUKP) holds a mixture of industrial, residential and commercial UK properties through share holdings in companies such as Land Securities (LAND), British Land (BLND), Hammerson (HMSO) and Segro (SGRO), all of which feature in its top 10 holdings. In contrast, a direct property fund such as IC Top 100 Fund Standard Life Investments Property Income (SLI) holds offices, retail and industrial properties in the UK.

Investing in Reits rather than direct property reduces one vital benefit of commercial property: diversification. And it means property ETFs are more likely to perform in line with the wider stock market rather than delivering uncorrelated returns like illiquid property assets can.

Over five years European property ETFs have demonstrated a similar pattern of returns to the MSCI Europe and FTSE 100 indices. But the closed-end direct Europe property sector has shown the opposite tendencies to both those indices over that period.

"The fundamental problem is that directly owning commercial property does not fit well with open-ended funds because of illiquidity," says David Liddell, chief executive of online investment service IpsoFacto Investor. "But investing in ETFs or funds that own property shares, which are a geared play on the property market and hence the well-being of the local economy, don't tend to give you much diversification benefit from owning other listed equities. Of course there may be a point when they are attractive as part of an equity portfolio but they do not necessarily do a good diversifying job."

There are only two ETFs focused on UK property but there are a number of internationally-focused ones which have very low ongoing charges, in some cases as cheap as 0.4 per cent. Trusts and funds invested in overseas property can cost investors much more: for example, Macau Property Opportunities (MPO), an Asian property investment trust, has an ongoing charge of 3.28 per cent.



The sector average cumulative total return for the Investment Association Property sector, which covers a range of geographies and includes both direct and property securities funds, was 12.5 per cent over one year and 8.3 per cent over six months. The average Europe property ETF made 4.8 per cent over one year and the average international property ETF made 14.3 per cent.

Of the European ETFs available to UK retail investors, the top performer over five years is db x-trackers FTSE EPRA/NAREIT Developed Europe Real Estate UCITS ETF (XDER), which has returned 91 per cent. It has also generated a positive return in the period since 24 June, at just over 12 per cent.

When compared with active funds though, the income on these ETFs tends to be lower because they are invested in company shares, rather than physical property which generates rental income. And some property ETFs do not offer dividends so check before you invest.

For example iShares European Property Yield UCITS ETF (IUKP) has a yield of 1.93 per cent . By contrast, M&G Property Portfolio (GB00B89X8P64), one of the open-ended funds which has suspended redemptions, has a 12-month yield of 3.92 per cent, and Kames Property Income (GB00BK6MJF73) has a 12-month yield of 5.38 per cent.

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By Kate Beioley ,
01 September 2016

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