23 November 2016

Is the ‘yield trade’ over?

This is not the first time that market pundits have signaled the end of the ‘yield trade’, though the case for it today is perhaps the most compelling to date.

The ‘yield trade’ refers to the appetite that investors have had for areas of the equity market that offer relatively high and reliable dividend yields which are attractive when compared to more traditional sources of income, such as fixed interest. Areas of particular appeal in the equity space have included utilities, telecoms and listed property trusts (or AREITs in Australia).

These areas of the markets had been among the market leaders over the last few years in an environment when bond yields were falling, as equity investors chased the more attractive yield on offer. However, this trend has reversed in the last few months as bond yields have started to tick up. Rising bond yields hurt the ‘yield trade’ given the negative correlation to interest rate moves.

Since August, we have seen the 10-yr bond yield in Australia rise from a low of 1.8% to above 2.6% today. The initial move was in sympathy with the move higher in the equivalent bond in the US, where signs of emerging inflation are likely to prompt a December interest rate hike by the US Federal Reserve. After Trump’s election success in the US in early November, this move has accelerated, prompted by the belief that his domestic policies may stoke inflation further.

Over the 3 months to the end of October, the rotation out of these yield-driven sectors has been pronounced, with falls of over 10% from recent peaks and much of the year-to-date performance given back.

Looking at AREITs in particular, the calendar year performance for the S&P/ASX 300 Accumulation Index has now come back to +5.2% at the end of October, sharply lower than the +22% advance that had been recorded at the end of July.

Given this pull-back, there are 3 things for AREIT investors to consider:

a) How high will bond yields go (and how quickly will they get there)? While it seems possible that we have seen the lows in bond yields, it is far from clear that inflationary pressures are such that we see yields continue to move sharply higher from here. It is also important to remember the longer term pressures that have been weighing on bond yields over the last few years – demographics and an ageing population, high leverage already in the system, the deflationary impact of technological disruption to name but a few. These inflation-dampening pressures are still with us.

b) Regardless of the ‘yield trade’, is there value in owning AREITs today? It’s clear that, given the recent pull-back, valuations today are more attractive than they were 3 months ago. The distribution yield is now over 5% and the sector has pulled back to a healthy discount to Net Asset Value (NAV), suggesting that the sector is slightly cheap against an admittedly elevated physical market. Further support is evident in reasonable underlying earnings growth, exposure to steady income across a diverse range of property asset classes and a sector that continues to be prudently leveraged.

c) How much more selling to come by equity investors? This also remains unclear, though the sharp move already seen would suggest that the rotation out of these ‘yield trade’ defensives is well under way, supported anecdotally by signs that some equity investors have now moved to an underweight position in their exposure to AREITs.

Taking this one stage further, the case for active management within the AREIT sector is also brought to the fore. If we are returning to a more normal return environment for the asset class of 8-10%, any additional return that the best active managers can deliver becomes more meaningful.

The Zurich Investments Australian Property Securities Fund, managed by the highly-regarded Renaissance Property Securities, has been able to deliver outperformance by finding the most attractively priced stocks and sub-sectors, most recently in the rapidly improving Sydney office market. True to the investment team’s mantra that value ultimately gets recognized, the fund combines rigorous in-depth research, extensive AREIT experience and nimble decision-making to exploit market inefficiencies for the benefit of the fund’s investors.

Zurich Investments Australian Property Securities Fund
Annualised fund performance after fees – to end October 2016

1 year

3 years

5 years

10 years

Fund

8.7%

13.5%

18.2%

2.2%

Benchmark *

6.4%

13.6%

16.8%

0.7%

* Benchmark is the S&P/ASX 300 AREIT Accumulation Index

 

Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated November 2016, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.
Past performance is not reliable indicator of future performance. GINN FVHHKJ.00012.ME.036.

CSTT – 011949-2016

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