September 10, 2014

Your asset allocation guide – September 2014

There are options to consider when allocating property to your portfolio. NAB Private Wealth aligns its views with those of institutional investors and favours core unlisted commercial property, with low to moderate gearing, rather than listed property securities or residential property.

Our asset allocation recommendations contain suggested exposures to property.  However, investors have many options when they consider an allocation to property in their portfolio.

They can buy commercial properties or invest in a managed fund that buys unlisted commercial properties, or they can buy property securities traded on the stock exchange. Investors may also own residential investment property directly, or through a self-managed superannuation fund.   So, what do we mean when we talk about property, and should all property types be treated the same? For example, should listed property securities be viewed as property or shares, and will a leveraged residential investment property provide all the risk, return and diversification benefits that are required in a diversified portfolio?

Many advisers argue that listed property securities (for example, Westfield Group) should be viewed as just another listed industry sector – much like retailers or media companies, which are also listed on the stock exchange.  And since many Australian share funds invest in property stocks anyway, you still get exposure to property securities through your allocation of Australian or international shares.

Moving to residential property, many of us are already heavily exposed to this asset class, and rental yields are either very low or negative (if geared). Therefore, it isn’t necessarily providing income or diversification, particularly if house prices are linked to interest rate cycles.

As such, our views tend to align with those of institutional investors. We believe the best form of property investment is core unlisted commercial property with low to moderate gearing, rather than property securities or residential property. This view was vindicated during the Global Financial Crisis, when securities in highly leveraged, listed property companies – such as Centro and GPT – plummeted with equities markets. By contrast, core unlisted commercial properties retained their values, maintained their rental income streams and provided strong portfolio diversification.

Our asset allocation summary:

  • Cash: Hold a slight overweight position until better opportunities emerge. We suggest term deposits out to two years are preferred over at-call cash.
  • Fixed income: We suggest an overweight position. Developed world government bonds are expensive and offer poor absolute value, so we prefer products with limited interest rate risk. Consider an equal split between Australian and (hedged) international bonds.
  • Australian equities: Remain underweight. Valuations are somewhat stretched and growth is lower than in other markets, meaning attractive opportunities in the Australian share market are harder to find.
  • International equities: Given higher valuations in developed market shares, hold a neutral weighting. An unhedged allocation gives some protection if global growth disappoints as the currency is likely to decline. Emerging markets are relatively cheap, so maintain exposure either directly or indirectly through the emerging markets earnings of global companies.
  • Alternatives: Maintain a neutral allocation until opportunities emerge.
  • Property: Hold a neutral allocation to commercial property. Demand for core property is robust and rental growth fundamentals should improve. At current pricing, Australian and international property appears fair value.

For further analysis, download the full report.

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