Retail de-rating could compound problems for UK property funds

Billion-pound UK property funds like the frozen M&G Property Portfolios are being called out for their hefty exposures to brick and mortar retailers which face disruption from the growth of online shopping.

M&G Investments suspended dealing on its £2.5bn Property Portfolio and feeder fund on Wednesday. The asset manager blamed “continued Brexit-related uncertainty and ongoing shifts in the UK retail sector” for triggering the “unusually high and sustained outflows” that prompted it to temporarily shutter the fund.

But this explanation didn’t sit well with SCM Direct co-founder Gina Miller who called it a “distraction” on M&G’s part and queried why it had allowed its exposure to the beleaguered UK retail sector to creep upwards.

Miller noted there has been continued Brexit-related uncertainty “on most days since the June 2016 referendum” and that “the downfall of the high street” market “has been a feature for years now” noting the fund’s independent valuer Knight Frank slashed the value of its retail investments by 7.7% this November.

“The real question is why did M&G decide to invest as much as 36.4% of the fund in Retail properties according to its March 2019 account?” Miller asked.

Retail warehouses, shopping centres, designer outlets and supermarkets now make up 40% of the M&G Property Portfolio, according to its October factsheet.

Breaking down UK property funds’ exposure to retail

The M&G Property Portfolio is not alone in having hefty exposure to the besieged UK retail market.

Portfolio Adviser found UK direct property funds were holding between 20% and 50% in retail assets, according to their latest factsheets.

The Aberdeen UK Property fund had the highest exposure to retail properties of the 11 funds examined with 49.5% of the portfolio held in this type of asset.

Aviva Investors, Janus Henderson, Canada Life, Kames Capital and Royal London had around a quarter of their open-ended property funds invested in retail properties, while Standard Life Investments and Columbia Threadneedle had over a third.

Source: FE Analytics

Property funds could de-rate further

Louis Tambe, fund analyst at FE fundinfo, says valuations in the direct property market are a growing concern.

“In the listed real estate and Reit market, prices have already begun to reflect much of the struggles with the sector, particularly high street and shopping malls,” says Tambe.

“However, in the direct market due to low transaction volumes on the back of UK political and economic uncertainty, the transaction prices are yet to fully reflect the extent of the problem and therefore we could see more de-rating leading to issues with other direct property funds with a high exposure to retail.”

Tilney managing director Jason Hollands says that because property funds cannot be repositioned easily based on near term outlook, the mix of assets owned and exposure to different parts of the market will evolve over time.

“The relatively high exposure to retail properties has left the fund more vulnerable to recession concerns this year than some other funds, as well as the structural shift towards online shopping which has taken place over a longer period,” he says.

Not all retail is focused on the high street

While the M&G Property Portfolio has one of the highest exposure to retail properties in the sector, AJ Bell head of active portfolios Ryan Hughes notes its exposure to traditional high street names is lower than other sub-sectors.

A breakdown of the fund shows it has 21.5% in warehouses versus 8.2% in shopping centres, 5.1% in designer outlets and 2.7% in what it classifies as “standard retail”. Another 2.5% is held in supermarkets.

“The fund does have a large part of the portfolio exposed to retail but it’s important to remember that not all retail is the same,” Hughes says.

“Performance has clearly been challenged in the fund over the past 5 years and running an overweight to retail will not have helped given the challenges that this area has faced.”

It’s not being exposed to retail property in a daily-dealing, open-ended fund that is the problem but “being exposed to physical property full stop,” he adds.

Retail parks in the North highlighted as a riskier bet

M&G’s and Aberdeen’s weighting toward shopping centres has also been highlighted as a riskier bet.

Both funds are invested in retail parks in the North of England, one source noted, which have been disproportionately battered by the Brexit-led economic slowdown.

Aberdeen UK Property held 18.6% in shopping centres at the end of October, according to its latest factsheet, while M&G had a smaller portion (8.2%) invested in retail parks.

Investment into shopping centres has continued to slump throughout the year. Research from Savills shows volumes across the sector stood at £677m across 20 deals by the end of Q3 compared to £974m across 27 deals in the same period of 2018.

It described deal volumes in the third quarter as particularly “subdued” with only six transactions, worth a combined £102m, being completed.

Hughes says the investment case for shopping centres depends heavily on the quality of the tenants.

“Businesses such as Next have looked to this type of retail as a method of click and collect while others such as Homebase have closed down,” said Hughes. “You would certainly imagine that any new potential tenant is going to be looking for a pretty attractive deal to move into a property given the retail environment at present.”

Property funds distance themselves from M&G

A spokesperson for Legal & General Investment Management says its £3.2bn property fund has “relatively low exposure” to the retail sector which has been performing poorly relative to other sectors. It has zero exposure to shopping centres.

Instead co-managers Michael Barrie and Matt Jarvis favour the industrial sector, which accounts for 36% of the fund, and alternative property investments like hotels and student accommodation.

“We feel that these areas of the market continue to offer greater return prospects and also help ensure that the portfolio remains highly diversified,” the spokesperson says.

BMO UK Property fund manager Guy Glover was also keen to tout the fund’s lack of exposure to high street names.

“High street retail now represents just 6.9% of the fund, primarily made up of single unit shops at small lot sizes for which there are a larger pool of potential buyers,” says Glover. “The fund has no shopping centre exposure and the retail warehousing is focused on Greater London and the South of England, ensuring a robust residential underpin.”

He says has sold down some of the fund’s retail exposure “in light of the structural challenges” facing traditional brick and mortar outfits like shopping centres and department stores amid the online retail boom.

Location, location, location

Kames Property Income and Threadneedle UK Property Authorised Investment have higher weightings toward high street retailers (18.4% and 13%) but representatives from the respective firms say they choose properties in areas with high footfall.

Kames’ property fund favours smaller, more liquid sites, worth between £2m to £15m, in prime positions on the high streets in the top 50 to 75 of UK towns.

A Columbia Threadneedle spokesperson says a proportion of its retail holdings constitute a fully let “island site” in the centre of Reading “which has considerable development upside”.

Aviva Investors says it is “extremely selective” with its property investments and only looks to invest in “resilient economic centres” like Manchester, Greater London and Cambridge, as well as smaller centres like Exeter in sector-specific cases.

“We believe there remains a strong case for having retail exposure in a balanced property fund,” a company spokesperson says.