Endowus Satellite Portfolios: On global real estate — a 2022 update

What’s the outlook ahead for property stocks?

With interest rates spiking, the real estate investment trust (Reit) market has been hammered this year as the yields provided by these equity instruments lost their relative shine, compared with their clear appeal in the previous low-rate environment spanning more than a decade. 

The growth of Reits is driven mainly by acquisitions on cheap debt. As financing gets more expensive, this growth path becomes less compelling. To add, Reit managers depend on occupational management to ensure that sustainable rental income is flowing through. Given the current concerns over a global economic slowdown, that puts further pressure on rental income and, by extension, distribution yields.

That said, the Endowus Investment Office continues to believe that the real estate market brings diversification potential to an equity and fixed income asset mix.

The table below shows the correlations between three market indices — the FTSE EPRA Nareit Developed Index, which tracks listed property companies and Reits worldwide; the MSCI World Index, which represents large and mid-cap stocks in developed markets; and the Bloomberg Global Aggregate Index, which tracks investment-grade bonds — over a 10-year period ending 31 Oct 2022. 

The important takeaway here is that while you might see higher correlations in a shorter period, over the long term, there is value from the lower correlations between the three asset classes and, in particular, the sources of income and yield.

While the higher interest rate climate has created headwinds for Reits, there is still cause for optimism for this asset class. Most listed properties tend to be of high quality with strong operating fundamentals. 

The sell-off this year has also created a disconnect between the valuations of Reits and their intrinsic value, thus paving the way for higher returns in the future.

How we constructed the Endowus Global Real Estate Portfolio: a recap

The Endowus Global Real Estate Portfolio offers dividends and long-term capital appreciation via access to the global real estate and infrastructure markets. Notably, it presents investors with an attractive current underlying dividend yield of 4-6% per annum.

Investors get indirect exposure to the underlying physical assets owned by these companies, as they buy into listed real estate companies that own, finance, or develop income-producing physical properties such as retail shopping malls, office buildings, and logistic warehouses. Global Reits make up 60% of the portfolio, and the remainder comprises property developers and infrastructure investments.

Underlying funds of the Endowus Global Real Estate Portfolio

Portfolio allocation of the Endowus Global Real Estate Portfolio

2022 performance

The Global Real Estate Portfolio underperformed the benchmark in the third quarter of 2022. Following a strong month in July, the portfolio pared all the gains and detracted -10.5% in Q3 as the global real estate sector significantly underperformed the broader market indices in the quarter. 

On a year-to-date basis, the Endowus Global Real Estate Portfolio has returned -27%, underperforming the various benchmarks.

This was mostly due to a chain reaction and the combination of a number of factors. The high inflation environment — caused by the global pandemic and supply-chain disruptions, and exacerbated by the Russia-Ukraine war — led to central banks hiking interest rates to tighten the supply of money and reduce consumer demand. The rise in interest rates had the unfortunate effect of increasing the cost of capital for Reits, which the Global Real Estate portfolio has significant exposure to.

Bond yields have also skyrocketed in tandem with rising interest rates. This has made investing in Reits a much less attractive option in the current environment. Capital outflows from Reit have also added to their performance challenges. 

Property developers and real estate operating companies (REOCs) have also been impacted by the broad sell-off in equities in the year to date.

Endowus Global Real Estate Portfolio returns

A core-satellite approach

Launched in November 2021, Endowus Satellite Portfolios are used to supplement the core portfolios and are meant to express an active decision by the investor to provide further diversification opportunities to try to generate alpha (above market returns), or to express a specific investment view or strategy. This can be done through a single fund or a portfolio of funds. 

Here’s how satellite strategies differ from that of core portfolios:

• They tend to be more concentrated in nature and narrow in exposure, targeting a certain sector or country or theme, as compared to the passive broad market exposure of core portfolios.
• While they may follow an index and can be passive, most satellite portfolios and funds tend to be active in the way they invest and seek to generate alpha.
• The investments tend to be shorter term in nature and reflect tactical or opportunistic investment strategies, as opposed to the strategic nature of core investments. 

Find out how our other Satellite solutions have performed in 2022 — click here to read about the Endowus Technology Portfolio and the outlook on tech stocks, or follow this link for an update on the Endowus China Equities Portfolio.

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