Focus on prime end of market has brought value to New Star UK Property fund
With all funds bearing the New Star prefix due to be renamed Henderson in April, New Star UK Property has seen a significant increase in performance since Henderson took over New Star Asset Management in May 2009.
The fund is up 13.5% over one year to 15 March according to Morningstar.
Launched in June 1999, the £777.45m vehicle aims to achieve long-term capital and income growth through investment in commercial property and property- related assets. Other investments may include money market instruments, derivatives and forward foreign exchange contracts.
When Henderson took over New Star, the fund was managed jointly by Marcus Langlands Pearse and Roger Dossett. In September 2009, Ainslie McLennan replaced Dossett and joined Langlands Pearse as co-manager of the fund.
The first two months of 2010 have seen a steady start for the UK commercial property investment market as capital values continue to increase, particularly for property at the prime end of the market.
The New Star UK Property fund experienced a positive valuation during February across the portfolio of around 1%.
According to McLennan, the focus has been on keeping the fund as prime as possible. Just prior to the end of 2009, the fund made its first purchase in over two years, acquiring a well-let department store in Chichester with around 30 years unexpired on the lease. This has already seen a strong positive capital appreciation, McLennan says,
Fund performance has also been aided by maintaining a strong income yield due to low vacancy rates of 3.8% at 26 February, a high property portfolio yield of 7.5% and a low cash holding of 23.9%. The portfolio also has a 34.6% weighting in offices, 27.2% in retail, and 14.3 in industrial.
McLennan says: “The recovery in valuations has happened despite the challenging macroeconomic situation in the UK.
“Strengthening of prime property yields has been driven by continued low interest and bond rates. Even secondary yields are beginning to see more meaningful positive shifts, partly driven by the recent shortage of stock to the market.”
The manager believes the fund has been able to take advantage of the upswing because the rally in valuations has tended to be concentrated in the more prime end of the market.
“Over the month, we completed some small vacant possession sales to tenants of industrial units. This further de-risks the fund and will remove further voids from the portfolio,” McLennan says.
She attributes the strong performance over the year to the decision to come out of some of the very small assets which the fund had when it came under Henderson’s management.
“The average stock size is now about £11m but prior to last April we had five or six assets that were between £3m and £8m.” she says.
“They tended to be shorter-term income and to be the assets where there were voids in the portfolio. We really did not want this to be our style of holding. We wanted to have much larger lot sizes and much more prime.”
By selling out of the smaller assets, the managers have been able to substantially lower the void rate within the portfolio. It currently sits at 3.8% in contrast to the current IPD voids benchmark of around 10% or 11%.
McLennan says: “By making these sales we also managed to increase our average lease lend across the portfolio to just under 11 years, which is pretty compelling by anyone’s standards.
“I think this is considerably higher than any benchmark would be for a UK portfolio, particularly an open portfolio.”
Occupationally, the fund has a strong, diverse tenant base with 114 tenants and around 90% of the income stream from companies with profiles considered to be low or negligible risk.
The manager believes the UK property market is unique because it is the only one globally where there are full repairing and insuring leases.
“The structure of the leases is such that people still tend to be able to get 10 to 15 year leases, which is very appealing to an investor,” McLennan says.
“As a result of this, UK property has become extremely attractive. A more short-term factor is currency has had a role to play for foreign investors wanting to be involved in the UK market, and creates demand for stock, which has been to our benefit.”
McLennan believes a property portfolio is worth diversifying into as part of any investor’s bigger fund.
However, she warns: “Investors need to make sure they drill down into the fund’s credentials and look at factors which such as weightings, strength of income, and potential for growth.”
Investors are spending much more time than they used to making sure they are getting the right funds these days, with liquidity a particular concern.
“Some of the retail funds have taken in huge amounts of money and are finding it difficult to play. This is obviously a concern for them,” McLennan says.
“We have 23.9% liquidity, which we are comfortable with, and we certainly would not want to be below 15% going forward.
“An open fund should maintain sensible liquidity levels. Bearing in mind the recapitalisation we have had I think it is sensible to make sure you have always got enough for everybody.”
McLennan believes the fund can sustain performance going forward. “Our fund has a net initial yield on the properties of around 7.5%, which I think is very compelling,” she says.
“Our distribution yield is around 4.6%, which is also much higher than most of our peers. I think this is sustainable partly because of the certainty I have over the income stream, and where the income is coming from.”
She adds: “Keeping our void rate low means the income should be there to distribute. We are trying to make this a real constant in our profile for investors.”
The managers are happy with a slow steady organic growth, rather than “rushing ahead with our yields and then seeing a dip.”
McLennan says: “It will be interesting to see if the market does slow down, and how all these different funds manage it.
“The retail investor can come in and out of a fund very quickly so liquidity is key and maintaining the right liquidity levels will be important going forward particularly over the short term.
“The most important thing to look at is the long-term outlook for property. The current climate is fairly accommodating for commercial property so it should be relatively positive.”
