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Dr Edward Trevillion
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Professional client use only not for retail clients. This document is intended only for the person to whom it has been delivered and may not be forwarded to a third party without prior consent from Scottish Widows Investment Partnership. Any investment decision should be based on the information contained in the appropriate Prospectus which should be read prior to investing.
Agenda
Conclusions
Scottish Widows Investment Partnership is one of Europes largest investment companies1 and the centre of investment management excellence for the Lloyds Banking Group Based in Edinburgh we employ 506 colleagues, including 168 of the investment industrys most experienced specialists2, across 3 investment locations Edinburgh, London and New York We specialise in high alpha equities, fixed income, real estate and multi-asset. We also offer a number of specialist strategies, including money-market, private-equity, multi-manager and absolute-return funds
Sterling Fixed Income 39.20bn Overseas Fixed Income 8.36bn Other Investments 2.97bn Real Estate 8.67bn
UK Equity 41.02bn
SWIPs clients range from banks and insurance companies through to private investors worldwide
% Capital Value
25% 20% 15% 10% 5% 0%
City Mid Town West End Inner London Outer London South East South West Eastern East Midlands West Midlands Yorkshire and Humber North West North East Scotland Wales NI Offshore UK Other
SWIP Annual Universe
Use of index linked bonds Really hedge against inflation? Better understanding of the real value of total returns from property, partly, because of the greater market transparency resulting from the IPD index. The removal of exchange rate controls in 1979 allowing institutions to achieve greater diversification overseas and reducing the importance of property as a diversifier. Dividend controls were also removed at about the same time allowing dividends on equities to be increased making them a more attractive investment medium. But revisionist view that weights ought to be increased (10-15%?)
30
25
20
15
10
0
1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Life funds
Pension funds
Research is fundamental to SWIPs investment style and philosophy Highly respected research team of six professionals Undertakes a range of work to underpin investment decisions and identify new areas for investment
Work includes
Market based analysis Performance measurement and analysis Risk measurement and analysis Transaction support and longer term research
Quarterly forecasts of future property performance for both the UK and Europe
Input into every investment proposal and also coordinate a bottom up review of the market and market risks which complement our top down strategic market reviews
Real estate remains a good diversifier for portfolios dominated by equities and bonds Performs well relative to other investment categories (risk/return)
Property as a diversifier
US Property
Eurozone Property Japan Property
0.09
0.17 0.20
0.05
-0.38 -0.10
9 Source: IPD, NCREIF, Datastream Bond indices, MSCI Equity indices UK & US data from 1981, Euro from 2001, Japan from 2003. To end of 2011.
?
2001 2002 2003 2004
Income return
Source: IPD Multi National Index: May 2011 (historic figures) and SWIP/JLL, December 2011 (forecast figures). Forecasts are opinion only, cannot be guaranteed and should not be relied upon when making investment decisions.
2005
2006
2007
Capital grow th
2008
2009
2010
Total return
2011e
2012f
2013f
2014f
2015f
10
Calm in a storm?
Bond Yields and Asset Price Movements 2011 - 2012
4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 03Jan 31Jan 28Feb 28Mar 25Apr 23May 20Jun 18Jul 15Aug 12Sep 10Oct 07Nov 05Dec 02Jan 30Jan 27Feb 26Mar 150 140 130 120 110 100 90 80 70 60
UK 10 Yr Bond yield (LHS) Euro Area (AAA rated only) 10 Yr Bond Yields (LHS) IPD Capital value index (RHS) FTSE All Share price index (RHS) Dow Jones Euro Stoxx Index (RHS)
A quiet summer for the property market despite the turmoil seen in other markets
11 Source: IPD, Datastream, ECB, April 2011. The above is provided for illustration and discussion purposes only.
12 Source: IPD, Datastream Global Equity indices from 1980 to 2010. The above is provided for illustration and discussion purposes only.
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$100
$80
USD TRILLIONS
$20
$0
Pros
Cons
Access to a larger universe of properties Potential access to faster growing economies Access to different sectors of the property market and at different stages of maturity
Currency risk Lack of transparency and liquidity in some markets Concerns over title/legal issues More limited data
London
$28 bn
Canada $16 bn
Toronto Vancouver $6 bn $1 bn
UK $51 bn
Central and Eastern Europe $21 bn
Istanbul
$0.8 bn
USA $169 bn
Paris New York Washington DC $29 bn $16 bn Berlin Milan
China $231bn
Tokyo Beijing
Shanghai Hong Kong
Japan $29 bn
$23 bn
$20 bn
$26 bn $20 bn
Boston
$6 bn
Frankfurt
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2.3% 2.8%
UK 2.2% 2.5%
1.4% 2.3%
9.7%
USA
2.5% 3.0%
3.1% 4.1%
Brazil
4.0%
2.4% South Africa 3.8% 2.6%
Transparency of markets
Highly transparent
Australia Canada
Transparent
Finland Spain
Semi transparent
Greece Slovakia
United Kingdom
New Zealand Sweden United States Ireland France Netherlands Germany Belgium
Austria
Singapore Norway Hong Kong Portugal Switzerland Italy Poland South Africa
Russia1
Romania Taiwan Chile Turkey Dubai Brazil Thailand India1
Denmark
Czech Republic
Malaysia
South Korea
China1
Japan
Hungary Israel
Mexico
Ukraine Philippines India Argentina Slovenia Abu Dhabi 18
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Market Phase:
Bottom
Early-Stage Recovery
Bear Market
Asset repricing Buying and selling opportunities leading to re-balancing portfolios Back to basics. Manage tenants and concentrate on income as a driver for total returns. Minimise outflows, rates, liabilities
Buying opportunities and bargain hunting can deliver future capital growth for the portfolios leading to enhanced returns
Psychology:1
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Sources: 1. Morgan Stanley/SWIP.
Offers a convenient method for choosing from mutually exclusive projects when capital
rationing prevails. Comparison between alternatives is simplified by ranking projects according
Popularity of IRR in part psychological: managers simply prefer a measure of investment worth
However: not uncommon to find that the margin between a projects success or failure hinges on the enthusiasm and commitment of the person sponsoring and implementing it.
See also R. Pike and W. Neale Corporate Finance and Investment: Decision and Strategies. Prentice Hall
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Errors on forecasts
No clearing price Lumpy inefficient market Rational pricing? Investor psychology Asset characteristics? Leases shortening affecting risk assessments
Dont want to tie into hurdle rates, which potentially have large errors and miss good opportunities so.
Should one take an holistic approach using market forecasts and IRRs simply as a guideline placing significant emphasis on the investment managers bottom up approach to individual assets.
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Tenure? Covenants? Property specific issues? Market commentary Occupational issues Investment market specifics Sector review conclusions house view positive/ negative/ neutral bottom up
Combine with research top down view positive/ negative/ neutral? Research input Fund issues weighting? Risk? Financial analysis yield considerations; IRR; Valuations Reasons for sale/ purchase
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Specialist active real estate expertise Emphasis on strong research capabilities and experience All asset identification and investment decisions driven by our research efforts:
Economic Team
House View
Fund Strategy
Portfolio Implementation
Transaction support
Sector Review
Focus on fundamentals to formulate a fund strategys business plan and inform decision making at the asset level
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Oxford Economics
UK and Segment specific forecasts for employment and output economic drivers
26
City offices
West End offices
RoSE offices
RoUK offices
Business parks
SE industrials
RoUK industrials
Distribution warehouses
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Shape of UK and regional economic output, employment, retail sales and Government bond yield forecasts stamp their mark on the shape of the property forecasts. Other macro-economic factors such as interest (swap) rates and inflation impact on yield forecasts but investor preference and the weight of money coming into property is clearly also important. SWIP Top Level forecasts include:
UK Economic Output
Retail sales
These ultimately drive UK and segment specific forecasts for employment and output economic drivers
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Driver 2
WE F&BS employment
MT F&BS employment
RoSE offices
RoUK offices Business Parks SE Industrials RoUK Industrials Distribution Warehouses
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Equivalent yields
Yield forecasts bring together assessments of a number of components and drivers of yield:
Risk premium
Rental growth
Inflation
Depreciation
Combined with a reversion parameter which dictates the extent to which yield forecasts are brought back to their long term fundamental value.
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A simulation model
Simulation model is effectively a cash flow model applied to the forecast IPD segments
Takes into account market void rates, lease lengths/renewals, degree of over-renting etc to produce estimates of:
Income returns
Total returns
Capital growth
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Main outputs
Total return
Addresses historic priorities but may change to more regionally specific markets
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Risk
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Specific risk is the variability in return due to factors unique to the investment
Can be diversified out and declines as the number of securities increases Historically measured by standard deviation (volatility)
Systematic or market risk is the variability in return due to the dependence on factors which influence the return on all securities to varying degrees
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Can estimate the current degree of risk (or risk premium) being attached to property by estimating the difference between property equivalent yields and a risk free rate Simplistically
y-b=r-g
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5%
4% 3% 2%
1% 0%
-1% -2% -3%
2008
2009
2006
2006
2006
2007
2007
2007
2007
2008
2008
2008
2009
2009
2005
2009
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
The perception of risk was low in 2007 but the reality was different
Is the risk premium now too high or correct in the current climate?
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Source: JLL, September 2011. The above is provided for illustration and discussion purposes only.
2011
2005
2005
2005
2006
2010
2010
2010
2010
2011
2011
Location risk
Location: An important diversification factor but different locations carry different risks We have attempted to quantify risk using more than just the volatility of returns
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Risk factors
F&BS/PA output
Services confidence
Offices
Occupier demand
Supply
Retail
Occupier demand
City preferences
Supply
Manufacturing output
Consumer spending Accessibility
Logistics
Occupier demand
Supply
Ranking scores for each risk factor: lowest risk =1, highest risk = 10
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Risk/return profiles
Risk return
14
12
10
Warsaw
Dublin
Paris
Milan Athens
The indifference curve is estimated relative to a well defined market London offices where the required rate of return is calculated according to CAPM A line of indifference is a line that shows all the possible combinations of two goods between which a person is indifferent ie a line that shows the consumption of two goods that will give the same utility (or satisfaction) to the person. Here is a line which shows combinations of the level of risk and return which an investor is indifferent
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Source: SWIP, December 2011. Forecasts are opinion only, cannot be guaranteed and should not be relied upon when making investment decisions.
Declining
End of Correction
Growth Stage
Beijing
NYC
Helsinki
Hamburg Stockholm Berlin Prague Lisbon Dublin Barcelona Washington DC Toronto
Munich
Warsaw London
Capital Values
Athens Madrid
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Source: SWIP/JLL/RCA, Q4 2011 outside Europe. European data as at Q1 2012. All data for offices
SWIPs approach looks at the drivers of property returns and how these can be used to rank locations in terms of risk The example for offices shows that:
Forecast returns for Athens well below those required for the given level of risk
Warsaw, Toronto, Shanghai and Prague offering higher returns for their risk profile
This approach is being used by SWIP in determining the appropriate investment for our European unit shops strategy Location offers opportunities because the evidence is that the global real estate cycle is not synchronous (although it may become so in the future)
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Conclusions
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Real estate still sits in the middle of the risk return spectrum of all assets
Clearly risk and how we mitigate risk needs to be addressed with some urgency in the present economic climate Sectors are not the key issue at the moment. In the current climate of uncertainty the quality of assets and markets is more important Depending on the location and local economy stock selection can offer:
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Is bond type property now more appropriate at this stage for the mature markets of the UK, US and Mainland Europe where huge economic uncertainties remain? BUT granularities in market and stock will always offer opportunities to beat forecast trends
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Important information
Professional client use only not for retail clients. The information contained in this document has been derived from sources which we consider to be reasonable & appropriate. It may also include our views & expectations, which cannot be taken as fact. This information is supplied to you in confidence & you may not pass it on to any other party without prior written consent. The value of investment is not guaranteed and can go down as well as up depending on investment performance. Past performance is not a guide to future performance. Furthermore, for non-sterling denominated investments, currency movements may cause an additional favourable or unfavourable change in value. Due to the above factors, investors may not receive back the full amount originally invested.
Investment markets and conditions can change rapidly and as such the views expressed should not be taken as statements of fact, nor relied upon when making investment decisions. Smaller companies may be less well established and carry a higher degree of risk than larger companies.
Forecasts are opinion only, cannot be guaranteed and should not be relied upon when making investment decisions. Funds under management are an internal estimate. Scottish Widows Investment Partnership 33 Old Broad Street London EC2N 1HZ Phone: +44 (0) 20 7203 3000 Fax: +44 (0) 20 7203 3289 swip.com Scottish Widows Investment Partnership Limited (SWIP) is registered in England and Wales, Company No. 794936. Registered Office is at 33 Old Broad Street, London EC2N 1HZ, UK. Tel: +44 (0)131 655 8500. SWIP is authorised and regulated in the UK by the Financial Services Authority and is entered on their register under number 193707 (www.fsa.gov.uk). Calls may be recorded and monitored to help improve customer service and for training purposes.
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