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Download Risk-adjusted returns - Hearthstone Investments
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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