Download Risk-adjusted returns - Hearthstone Investments

Residential Fact Sheet
Risk-adjusted returns –
the best risk-adjusted
total return
Risk-adjusted Total Return by Asset Class Over Time
1.2
1
Sharpe Ratio
0.8
0.6
0.4
0.2
0
-0.2
-0.4
5 Years
Residential Property
10 Years
20 Years
Commercial Property*
41 Years
UK Equities
Gilts
Source: Acadametrics, ARLA, IPD, Barclays Capital, Hearthstone. Data up to
December 2011 *IPD Monthly Index used for 1987 onwards
Market Analysis
The UK residential property market has shown the best total
return performance compared to equities, gilts and commercial
property over the medium to long term. However, this is only part
of the story. Investors must also take into account the level of risk
that is associated with returns. Risk is often measured in terms of
the volatility of an asset’s returns, and an investment/asset which
has high average total returns but also has a high variability in
those returns may not be the best choice. For residential, as well
as showing outperformance relative to other asset classes in
total return, the sector has been proven to have low volatility.
As a result, when a risk-adjusted return measure is calculated,
residential outperforms almost across the board.
Considered against commercial property, the reasons for the
resilience of residential are varied. In part, the lack of volatility
T +44 (0) 203 301 1310
E [email protected]
stems from the asset’s dual market position – within residential,
there is investment housing (private rented sector), social housing
and owner occupier markets, which overlap in a way which
commercial property sectors do not. Further, demand for the
asset will never be wholly based around economics, but will be
underpinned by other, longer-term social factors - whether
renting or buying, households can’t typically downsize to the
same extent that companies can reduce their office space.
For property against equities, it is not surprising that an ungeared
bricks and mortar asset that provides a known income stream is
less volatile than an asset price based on future growth in profits
within a business (a typical share price). Monthly movements in
share prices are often 4-5 times the movement in property prices
in the same month, and while it is true that both property and
W www.hearthstone.co.uk
|
Ref: August 2012/HS005
Residential Fact Sheet
Risk-adjusted returns – the best risk-adjusted total return
equities can post strong returns over a longer period, for those
whose investment is coming up to a defined end date (e.g.
retirement or buying a new home) property is an extremely
strong choice at that stage in the investment lifecycle.
IPD, while equity and gilts data is from the 2012 Barclays Equity
Gilt study. Performance has been calculated on a per annum
basis, with 2011 (the latest available annual data) as
the end-point.
Technical Background
A Sharpe ratio measures the excess return from an investment
per unit of risk i.e. it provides a form of risk-adjusted return that
can be used to compare different investments. The Sharpe ratio
is calculated as the total return of the investment minus the total
return from a risk-free asset (e.g. cash), divided by the standard
deviation of the investment.
Residential property is in emergence as an investment asset
class. Consequently, there is limited total return data available,
and in order to provide a realistic and informative long-term
data series, it has been necessary to combine different sources
of data. Our residential property total return is comprised of
a capital return taken from the LSL Acad house price index
(formerly the FT HPI) and an assumed constant gross income
return of 5.5 per cent (4.13 per cent net) until 2008. The gross
figure has been sourced from a GLA report, produced by
Savills, and reflects a 20-year average. The net figure has
been calculated by applying a 25 per cent discount to
the gross return, reflecting the approximate costs of property
management and maintenance in a large-scale residential
fund able to benefit from economies of scale. By using a
20-year, rather than the higher 30-year average of 6.2 per cent,
we are in fact presenting a relatively cautious view on historic
total returns. From 2008, ARLA buy-to-let rent figures (gross)
have been used and discounted by 25 per cent. The total
return data for commercial property has been sourced from
Important Information
Residential property prices can go down. Information on past
performance is not necessarily a guide to future performance.
The value of investments in a fund can go down, and there can
be no assurance that any appreciation in the value of
investments will occur.
Residential property values are affected by factors such as
interest rates, economic growth, fluctuations in property yields
and tenant default. Property investments are relatively illiquid
compared to bonds and equities, and can take a significant
amount of time to trade.
This information is intended for professional clients and investment professionals only and should not be relied upon by retail investors.
While all reasonable care has been taken in the compilation of this publication, Hearthstone Investments PLC will not be under any
legal liability in respect of any misstatement, error or omission contained therein or for the reliance any person may place thereon. This
report is published for general information only and while the report may be helpful in anticipating trends in the property market, no
warranty is given as to its accuracy, and no liability for negligence is accepted in relation to figures, forecasts, analyses or conclusions
in it. Under no circumstances must any of the content of this report be relied upon for investment purposes.
Hearthstone Investments PLC is the parent company of the Hearthstone Investments Group. Regulated business is carried out by
Hearthstone Asset Management Limited. Hearthstone Asset Management Limited is an appointed representative of Thesis Asset
Management PLC which is authorised and regulated by the Financial Services Authority (114354).
T +44 (0) 203 301 1310
E [email protected]
W www.hearthstone.co.uk
|
Ref: August 2012/HS005