Last updated: 23:00 / Monday, 13 February 2017
Interview with HSBC Global AM

Morrell: "There is an Increased Probability of a More Procyclical Fiscal Policy in The Developed Economies"

Morrell: "There is an Increased Probability of a More Procyclical Fiscal Policy in The Developed Economies"

In this interview with Funds Society, Guy Morrell, Head of Real Estate Investment at HSBC Global Asset Management, maintains that real estate shares have the potential to generate acceptable risk-adjusted returns, though lower than in the past. Therefore, dividend growth is a great support factor to beat public debt. And they also offer the potential benefit of portfolio diversification. Currently, his favorite markets are USA. and Australia.

Which is currently more attractive: investing in real estate directly, or through stocks linked to the assets?

Our strategy is to invest in real estate through listed real estate stocks rather than directly in buildings, for various reasons. First, we require a high level of liquidity for our strategy that is not available when investing in buildings, as buying and selling takes time. On the other hand, real estate sector shares offer a much higher level of liquidity. Secondly, building a portfolio of properties globally requires a lot of capital. A common characteristic of offices, retail premises, or good quality industrial properties is their large sizes. It is difficult to efficiently diversify the specific risk of construction. On the other hand, investment in real estate stocks exposes companies with large portfolios, which helps to overcome some of the portfolio-building challenges associated with direct investment. Finally, investing in physical buildings requires specialized and local experience in key markets around the world. When investing in real estate stock, we are investing in specialized management teams.

Therefore, for our particular needs, investment through real estate stocks offers significant advantages as compared to direct investment. This does not mean that investment in buildings is inappropriate for some strategies. Large investors who can allocate large sums of money to acquire properties globally, and who do not need liquidity, may find that investing in buildings is an appropriate way to access this kind of asset. The key is to ensure that the way to access this asset class is consistent with the objectives and investment requirements of the clients.

How can you manage and control the risk of equity-linked volatility in a fund like the HSBC Global Real Estate Equity?

Real estate stocks are more volatile than direct properties, although this is due in part to the infrequency with which property valuations are made, which tend to be based on historical evidence. That said, there are certain features of our strategy that are worth highlighting. First, we have a preference for stocks that generate a high level of recurring income. Therefore, we avoid companies that generate most of their returns purely through development activity, which tends to be very cyclical. In addition, we have a preference for companies that have low levels of debt, since excessive leverage can exaggerate market cycles. Finally, we seek to bias the portfolio towards markets that we believe offer acceptable returns over the long term. While we cannot avoid the volatility associated with real estate stocks in general, our strategy seeks to benefit from the characteristics of the long-term performance of the property that produces the income, but in liquid form

Which do you consider to be currently the main attractions when facing equities linked to real estate?

Real estate stocks have the potential to generate acceptable risk-adjusted returns. They provide a dividend yield that has historically been higher than that of other stocks. And there is the prospect of dividend growth, since rental income generated by real estate stocks responds to the economies on which they are based. There is also the potential benefit of diversification because real estate stocks are not perfectly correlated with other long-term asset classes. In the short term (for example, for some months), there is a reasonably high correlation between stocks of real estate companies and other types of stock. However, as the period over which stocks are held increases, the correlation between real estate stocks and other types of stocks tends to decline. Similarly, in very short-term periods, there tends to be a weak correlation between real estate stocks and the underlying physical property. But as the period over which the stocks are held expands, the correlation between the real estate stocks and the underlying physical goods market strengthens.

And what are the main risks this year?

Potential risks take various forms, including uncertainty about the prospects of the global economy, the effectiveness of economic policy and political developments, including the rise of populism. From time to time, these could lead to periods of episodic volatility. However, we remain reasonably positive with our prospects. Regarding major economies, global cyclical activity has increased since mid-2016. While growth is likely to remain mediocre as compared to historical levels, there is reasonably resilient growth in the US, acceleration of the dynamics in the Euro zone and an improvement in activity in parts of Asia. It also seems that we are entering a period in which global fiscal and monetary policies are more coordinated. Interest rates are likely to remain relatively low (compared to the average levels of the last 30-40 years), even allowing for some increases in certain economies.

Can a U.S. interest rate increase affect the asset?

The effect of interest rates increases on asset prices depends on the underlying reasons and the magnitude of the increases. If they occur due to stronger economic growth and are gradual, then we believe that this would be a reasonably positive environment for REITs. Investors are likely to have already taken into account a modest increase in interest rates, and an improvement in the economic environment could be expected to lead to an increase in rents and to the net operating income of the REITs. However, if interest rates rise unexpectedly, or if the increases are in response to high inflation but weak growth (a stagflation scenario), then REIT prices may be adversely affected. Taken together, we believe that the first scenario is the most likely - when the incremental interest rate increases occur due to improved fundamentals - rather than to stagflation.

And political risks: elections in Europe, Trump in the US...?

Political risks could lead to periods of asset price volatility. While increasing populism may remain a concern for some time, it also increases the likelihood of a more procyclical fiscal policy in developed economies. This could lead to more constructive reflationary policies, in contrast to the more deflationary stance of recent years. Such an environment could, in the long run, benefit REITs by increasing their net operating income. And from a global perspective, rather than one that maintains a national or regional focus, this means that our strategy has an element of geographic diversification.

You invest globally: in what regions do you currently see greater opportunities for your fund?

We believe that certain markets in the United States offer risk-adjusted returns that are reasonably attractive due to a positive economic outlook combined with favorable competitive bidding. Within the Asia Pacific region, Australia is our preferred market.

Within Real Estate, in what sectors do you see the greatest appeal?

While our preferred sectors vary geographically, we have a general preference for the retail and logistics sector over the office market. In the United States, where there is a higher level of sectoral specialization than in other markets, we also see value in the self-storage and residential sectors.

What returns can be expected from these investments in stocks related to real estate?

We expect lower absolute returns on Real Estate sector stocks as compared to historical long-term averages. However, based on our estimates of future dividend growth, we believe that global real estate stocks are reasonably priced to offer acceptable long-term returns as compared to core government bonds.