One of the most common questions that is currently asked by clients is what the prospects are for commercial property in the future. We have all by now – in our new normal world - got used to meeting our dearest friends, family, and work colleagues on Zoom or Skype, working from home, and shopping online.  High streets and shopping malls were struggling even before the events of 2020 with Debenhams and several middle-market food chains in trouble.

That has led some investors to beg the question as to what the future holds for commercial property. Will everyone work from home? Will companies reduce their office space needs, providing workers with a hot desk each morning, if they are in? Will retail companies go into administration to put pressure on landlords to reduce rents?  Will more people shop online? The answer to all of these questions is probably ‘yes’. Does that mean that we should abandon a well-diversified, liquid exposure to global commercial property accessed via real estate investment trusts (REITs), which are listed property companies, focused almost exclusively on generating rental income? We think not.

First, let us look at the flipside of the changes that are occurring. To be sure, some sectors may struggle.  But for every Debenhams, there will be a company moving into, or even starting up, online, which will require logistics centers and warehousing. In our digital age, there is increasing demand for secure and up-to-date data centers, improved and more numerous healthcare facilities for example. You can see from the chart below that the global commercial property REITs cover many things.

In a globally diversified REIT index fund, there are over 350 individual REITs (listed property companies) each of which is comparable to a property fund in its own right. It is estimated that such a fund contains around 90,000 properties[1] spread across property types, global markets, and strategies.

Second, let us spend a moment thinking about markets. These worries about the retail sector, for example, have been around for some time and you will not be the only person thinking about these issues. In fact, thousands - or even millions – of people will already have done so and acted on their view of the future of property, by buying and selling these REITs in the market. The aggregate view will be reflected in today’s REIT prices: all the doom, gloom and uncertainty is priced into the process of REITs already;  all the likelihood that the way we work changes is priced in already; and all the good news about data centers and warehousing is priced in already. So, the future prospects for commercial property will depend on what happens relative to this expectation.  It may be better or worse, depending on information we do not yet know. The release of that information is random. What we do know is that commercial property will continue to be needed and that companies will have to pay rent. We would not abandon owning a diversified equity portfolio because some sectors are struggling (airlines and energy) or concentrate our portfolio in sectors that are booming (technology). It is already in the price. Companies and sectors wax and wane.

Third, let us think about why we hold it in portfolios in the first place. Property tends to have a different return experience to equities (even though property companies are listed on stock markets). At specific times, and across time, this can provide diversification to a portfolio. In addition, over time property has provided protection from inflation; after all, a property is a property and many rental agreements are linked to some measure of inflation. With the rapid increase in the money supply, on account of all the government support packages around the world, higher inflation - not something most feel the need to worry about currently – is one future scenario. Cover the bases - but all things in moderation - is a sensible approach. An allocation to global commercial property still makes sense for long-term investors, as part of their diversified growth assets.

[1] Source: Prologis is the largest REIT at 5% of the index and owns ~4,500 properties.  Scaling this up implies around 90,000 properties across the index, as a rough proxy.

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Investors love good stories. In recent years, many of these stories have centred around innovations that have fundamentally changed the way we live our lives. Some examples might include the release of the original Apple iPhone in 2007, the delivery of Tesla’s first electric cars in 2012 and the launch of Amazon Prime’s same-day delivery service in 2015 . No doubt, many of you will have had conversations with friends and family around the successes, failures, and prospects of some of the world’s largest firms and the goods and services they offer. In this note, we take a deeper look at the ‘Big Five’ tech companies – Amazon, Apple, Alphabet (Google), Facebook and Microsoft – through the lens of the long-term investor.

In what has been a turbulent year thus far, some larger firms have come through the first - and hopefully last - wave of the ongoing pandemic relatively unscathed. Those investors putting their nest eggs entirely in any combination of the ‘Big Five’ would appear to have done astonishingly well relative to something sensible like the MSCI All-Country World Index, which constitutes 3,000 of the world’s largest firms . At time of writing, Amazon’s share price has fared best, increasing 75% since the beginning of the year.

 Figure 1: The 'Big Five' have held up well so far this year

Data source: Morningstar Direct © All rights reserved. Returns in GBP from 01/01/2020 to 22/07/2020.

These types of firms tend to struggle to stay out of the headlines for one reason or another. Perhaps as a result, many of the investment funds found in ‘top buy’ lists - such as the one on AJ Bell’s Youinvest platform - have overweight positions in one or more of these stocks. The final column in the table below shows the weight of each ‘Big Five’ stock as it stands in the MSCI All-Country World Index.

If an investor were to adopt a purely passive investment strategy that owned each company as its proportional share of the world market, the final column would be that investor’s top 5 portfolio holdings at time of writing. Many of today’s most popular funds are making big bets on one or more of these companies, anticipating that the past will repeat itself moving forwards.

Table 1: AJ Bell's top traded funds in the past week

Data source: Morningstar Direct © All rights reserved. AJ Bell for top traded funds between 15/07/20 – 22/07/20.

Sticking to the long-term view

The challenge for these managers, and others making similarly large bets, is that these are portfolios that will be needed to meet the needs of individuals over lifelong investment horizons, which for the vast majority of people means decades, not years. With the benefit of hindsight, managers who have placed their faith in these firms have stellar track records since Facebook’s IPO in 2012, as the table below highlights.

Table 2: ‘Big Five’ performance since Facebook’s IPO

Data source: Morningstar Direct © All rights reserved. Returns from Jun-12 to Jun-20.

An interesting exercise would be to investigate the outcomes of these firms over a longer period of time, for example 30-years seems more prudent. This is somewhat difficult given that 30-years ago, 3 of these firms did not exist, Mark Zuckerberg was 6-years old, Apple came in at 96th on Fortune’s 500 list of America’s largest firms and Microsoft had just launched Microsoft Office .

A partial solution to this problem is to perform the exercise from the perspective of an investor in 1996, which is the start of Financial Times’ public market capitalisation record . The ‘Class of 96 Big Five’ consisted of General Electric, Royal Dutch Shell, Coca-Cola, Nippon Telegraph and Telephone and Exxon Mobil. The chart below shows the outcomes of each firm over the past 26-years. A hypothetical investor with their assets invested in either Coca-Cola or Exxon would have just about beaten the market over this period, those in Royal Dutch Shell, Nippon Telegraph and Telephone and General Electric were not so lucky.

This experiment is illustrative only, one look at the chart below is enough to see that almost no investor would want to stomach the roller coaster ride they would have been on in any one of these single-stock portfolios.

Figure 2: The winners do not necessarily keep winning

Data source: Morningstar Direct © All rights reserved

Summary

The beauty of the approach you have adopted is that judgemental calls such as these are left to the aggregate view of all investors in the marketplace. No firm is immune to the risks and rewards of capitalism; be it competition from Costco or Walmart taking some of Amazon’s market share, publishing laws causing Facebook to apply heavy restrictions on its users or some breakthrough smartphone entering the marketplace that is years ahead of Apple – remember Nokia?

Rather than supposing that firms who have done well recently will continue to do well, systematic investors can rest easy knowing that they will participate in the upside of the next ‘Big Five’, the ‘Big Five’ after that and each subsequent ‘Big Five’. Those who can block out the noise of good stories and jumping on bandwagons are usually rewarded in this game.

Figure 3: Your eggs are in many baskets

Source: Albion Strategic Consulting. For demonstrative purposes only.

Risk Warning This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.

One of the hardest concepts to grasp in investing is that a ‘good’ company is not always a better investment opportunity than a ‘bad’ company. If we believe that markets work pretty well – not unreasonable given that few investment professionals beat the market over time - and that they incorporate all public information into prices pretty quickly and efficiently, all of the ‘good’ and ‘bad’ news should already be reflected in these prices.  A ‘good’ company will have to do better than the aggregate expectation set by the market for its share price to rise and vice versa.  If a ‘bad’ company is in fact a less healthy company, it may have a higher expected long-term return, as risk and return are related.  

It is perhaps evident that if the market incorporates the aggregate forward-looking views of all investors, it becomes very difficult to choose which companies, sectors, and geographic markets are likely to do best, going forward.  In an uncertain world, where stock prices could move rapidly, and with magnitude, on the release of new information - which is itself a random process – then it makes good sense to ensure that an investment portfolio remains well diversified across companies, sectors and geographies.  Take a look at the chart below that illustrates how deeply diversified a globally equity portfolio can be.

 Figure 1: If you do not know which stocks are going to outperform well, own them all

Source: Albion Strategic Consulting. Data: Morningstar Direct © 2020. All rights reserved.

The concentration risk in the US’s S&P500, is quite different.  

Figure 2: The US’s S&P500 is increasingly concentrated in a few names. 

Source: Albion Strategic Consulting. Data: Morningstar Direct © 2020. All rights reserved.

Given that all the future promise of a company is already reflected in its price today, it is quite a risk betting a large part of your assets on just a few names, concentrated, for example, in the technology sector.  The top 8 technology stocks in the US now have a larger market capitalisation than every other non-US market except for Japan.  Dominance of companies, sectors and markets ebb and flow over time.  Who is the next Amazon?  What regulatory pressures could these dominant companies face?  Is Donald Trump’s recent rage against Twitter the start?  No-one knows.  By remaining diversified, you will own the next wave of market leaders as they emerge and dilute the impact of ebbing companies.  Whilst it is always tempting to look back with the benefit of our hindsight goggles and wish we had owned more (take your pick), US tech stocks, other growth stocks, gold etc., what matters is what is in front of us, not what is behind us.  

‘The safest port in a sea of uncertainty is diversification.’

Larry E. Swedroe, Investment Author

Risk Warning This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.