Property: A valuable inflation-hedging diversifier in multi asset funds

Commercial property plays a valuable role in multi asset funds as a diversifying growth-seeking asset class alongside equities and as a long-term inflation hedge alongside commodities.

The potential introduction of 90-day or 180-day mandatory notice periods for redemptions from free-standing UK property funds increases the attraction of multi asset funds that include an allocation to the asset class, in our view.

UK property was hit hard by the spike in interest rates during the mini-budget crisis last autumn with total return indices off 18% from their highs. Our core strategies such as our Governed and GMAP ranges were tactically underweight over this period. The market is showing signs of stabilisation in recent months, however. Arguably property is the only asset class already factoring in a recession and, while we don’t expect a V-shaped recovery, we believe a lot of bad news is already in the price.

Royal London Asset Management has a long track record in managing commercial property in the UK, investing in high quality assets with sustainability at the heart of the process. Holdings include prime central London offices, retail parks, warehouses used for e-commerce and other commercial buildings. UK property has been a valuable diversifier to equities, offering a similar inflation-beating return over the long run (chart 1). While property can post negative returns during periods of global weakness, there are also times like the 2001-03 dot com bust when property continued to make progress despite a valuation-driven bear market in equities as the UK economy avoided a recession at that time.

Chart 1: Property and equities versus inflation over the long run

Source: Refinitiv Datastream as at 01/03/2023

We use a business cycle approach to aid our asset allocation decisions. Different asset classes perform at different times of the business cycle; we use our proprietary Investment Clock to ‘tell the time’ in the cycle, based on the direction of global growth and global inflation.

Historically property has offered its strongest returns during periods of economic upswing, the Investment Clock Recovery and Overheat phases (table 1). However, inflation resilience is also apparent in the fact that average real returns are stronger in the more inflationary in stages of the economic cycle, Overheat and Stagflation, than in those with inflation dropping.

Table 1: Asset class returns across UK business cycle phases

Past performance is not a guide to future performance.

Source: RLAM for illustrative purposes only. Data shows average return in RLAM defined phases of the business cycles. From April 1973 to December 2022.

UK property was hit hard by the spike in interest rates during the mini-budget crisis last autumn. Looking at data since the late 1980s, the 18% drop since summer 2022 is second only to the 37% drop during the Global Financial Crisis (chart 2).

Chart 2: Property drawdowns since the late 1980s

Source: Refinitiv Datastream as at 31/01/2023

While we may not have hit the low point, arguably property is the only asset class already factoring in a recession (chart 3).

Chart 3: Property appears to be already pricing in recession

Source: Refinitiv Datastream as at 31/01/2023

We have been underweight property in our Governed and GMAP ranges (chart 4). We don’t expect a strong V-shaped recovery in the market with the Bank of England still looking to squeeze inflation out of the economy and patience may be required. However, with a lot of bad news is already in the price, our next move is more likely to be to add to property than sell it.

Chart 4: Currently underweight property

Source: RLAM data

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.