AN INTERVIEW WITH
Lee Goldman, Kate MacDonald and Joshua Varghese
Signature Global Asset Management's Real Estate Team
Signature Global Asset Management, an affiliate of First Asset, enhanced its global real estate investment expertise with the addition of two highly experienced portfolio managers, previously with First Asset Investment Management Inc., a CI Financial company. On June 1, 2018, Lee Goldman and Kate MacDonald joined Joshua Varghese to form a new, larger investment team dedicated to real estate investing. They continue to manage First Asset's real estate investment mandates; CI First Asset Canadian REIT ETF and First Asset REIT Income Fund as well as approximately $4 billion of real estate assets across various CI funds.
In the following Q&A, the team outlines why CI First Asset Canadian REIT ETF (TSX: RIT) remains a compelling choice for investors, even in a rising rate environment.
Q: Can you explain the portfolio management changes affecting RIT and the key benefits of these changes?
We are all excited about the opportunity to consolidate resources and experience under the Signature umbrella – a move we believe will provide benefits for investors over the long term. While RIT will remain a Canadian-focused fund, it has the ability to invest up to 30% outside Canada. Being part of one of the largest real estate investment teams in Canada now gives us even more access to the best companies and opportunities around the world, and that provides our investors with both the benefits of greater diversification and the potential for enhanced returns.
Q: Why does the Canadian Real Estate Investment Trust sector remain attractive for investors?
We continue to see good value in a number of Canadian REITs. Canadian commercial real estate fundamentals remain broadly healthy outside of the Alberta office sector, backed by healthy demand/supply dynamics, rising rents in general, attractively priced debt and widespread expectations of continued robust direct property pricing; particularly for core and urban real estate.
Canadian REITs are trading at a mid-single digit average percentage discount to Net Asset Value (NAV), whereas the group has historically traded at a ~2% average premium to NAV. Historically, it has been a good time to buy REITs when they are trading below NAV. Generally, for REITs globally, the trading range is wide, with some issuers trading at double-digit premiums to NAV and others trading at double-digit discounts – highlighting the need for active management in the current environment.
At ~5% on average, Canadian REIT yields remain attractive on a relative and absolute basis. Over the last number of years, Canadian REIT management teams have focused on improving the quality of their portfolios, while also strengthening their balance sheets by reducing leverage and payout ratios over time – and thus creating better, stronger businesses over time. The average REIT payout ratio across the Canadian REIT universe is ~80% (2019 Adjusted Funds From Operations ("AFFO") payout ratio of 80% based on Bloomberg consensus AFFO estimates for the universe of Canadian REITs/REOCs tracked. Source: Bloomberg, First Asset. As at August 31, 2018).
Q: Why should investors own CI First Asset Canadian REIT ETF (TSX: RIT)?
RIT is the only actively managed Canadian REIT ETF. The fund has a long and impressive track record dating back to 2004 when it started as a closed-end fund. Since converting to an ETF in July 2015, the fund's assets under management has grown five-fold, showing how well the strategy has resonated with investors.
The five-year period ending June 30, 2019 is particularly notable since it included several market corrections, substantial interest rate volatility, and varied market performance for the REIT sector. RIT outperformed its benchmark, the S&P/TSX Capped REIT Index, over this time frame, generating an annualized return of 11.6% versus 8.4%, with 11%1 less volatility measured by Standard Deviation. As a result, RIT has a Sharpe Ratio greater than its benchmark over this period, having similar upside market participation with healthier downside as measured by both Up and Down Capture Ratios.
|Standard deviation||Alpha||Sharpe Ratio||Up Capture Ratio||Down Capture Ratio|
|CI First Asset Canadian REIT ETF||12.12||0.00||0.79||88.22||72.46|
|S&P/TSX Capped REIT Index (Total Return)||13.67||0.00||0.65||100.00||100.00|
|1Time Period: 11/15/2004 to 06/28/2019|
|1 Year||3 Year||5 Year||10 Year||SI|
|CI First Asset Canadian REIT ETF||12.98%||10.32%||11.63%||14.48%||11.05%|
|S&P/TSX Capped REIT Index (Total Return)||14.26%||8.89%||8.43%||13.61%||10.09%|
|Inception: 11/15/2004. As at 06/30/2019|
|The indicated rates of return are the historical annual compounded total returns, including changes in unit value and do not take into account sales, redemption or optional charges or income taxes payable by a security holder that would have reduced returns. The Fund was originally launched as a TSX-listed closed-end fund on November 15, 2004, and converted into an exchange traded fund on July 14, 2015. Performance shown is since inception of the closed-end fund. In connection with the conversion, and pursuant to unitholder approval, the annual management fee payable by the Fund to CI Investments Inc., as manager, was reduced to 0.75% (from 1.05%) of the NAV per unit and certain changes were made to the investment objectives, strategies and restrictions applicable to the Fund. Material among these changes is the ability for the Fund to invest up to 30% of its portfolio in securities of real estate issuers listed on non-Canadian stock exchanges and the Fund will no longer be permitted to use leverage. Had these changes been in effect prior to this date the performance of the Fund could have been different.
S&P/TSX Capped REIT Index is a capitalization-weighted index designed to measure market activity of the real estate sector issuers listed on the Toronto Stock Exchange. The Index is used as a benchmark to help you understand the Fund`s performance relative to the general performance of the Canadian real estate sector.
Q: For the last two years, interest rates have been rising. Many believe that a rising rate environment creates headwinds in the REIT space, yet RIT continues to hit new highs. Can you explain why?
Interest rates can certainly have an effect on REIT returns. Our thesis continues to be that REITs can do well in a rising rate environment if rates increase at a measured pace and if they rise because the economy is performing well. Those are the conditions that have prevailed for the last couple of years in Canada.
It's worth mentioning that although rates have climbed over the last two years, they remain low by historical standards. Canadian ten-year bond yields troughed at just under 1.0% in the summer of 2016; a level that concerned us, as a rate that low doesn't show much confidence in the economy going forward. Since that time, there have been some swings, but rates have generally been on the rise and now the 10-year Canada bond yield is around 2.15%. The move in rates has happened because the economy has been getting stronger. This generally means that buildings have lower vacancies and can command higher rents, so net operating income increases. The increase can more than offset any negative impact from higher interest rates.
Q: Describe the makeup of RIT and how each REIT sub-sector has performed.
The multi-family REIT sector has been the biggest sub-sector of the fund for quite a while, followed by an almost equal mix of industrial, retail and diversified REITs. The fund also has exposure to office, seniors housing REITs along with a couple of other niche sectors.
Multi-Family has been strong this year, both in terms of performance and fundamentals. Vacancy is tight across many markets, especially the Greater Toronto Area and Vancouver, resulting in the strongest lift in rentals that the sector has ever seen.
Industrial is also strong as e-commerce has led to a substantial increase in demand for logistics and warehousing space. Availability is at a 17-year low and new supply is muted, so rents should climb materially from here. There was also a high-profile take-out within the industrial space this year, with an affiliate of the Blackstone Group buying Vancouver-based Pure Industrial REIT at a sizeable premium to where the stock had been trading.
Retail is more mixed with e-commerce headwinds and department store closures, but operations have generally been holding up well and many retail names have great redevelopment/intensification potential. As a result, we remain constructive on many companies in the retial space.
Office market fundamentals are linked to geography. Toronto is the strongest office market in North America by vacancy. Vancouver is also very strong, while Montreal is improving. Calgary and Edmonton, on the other hand, are weak and will likely continue to be so for the foreseeable future.
Seniors housing is a sector we like, although there aren’t many names in this space. Canada’s seniors housing and care industry is booming, driven by demographics including an aging baby boomer population. The impact of this growing demand should start to materialize within results in the next year or two.
Q: Moving forward, what are some of the other themes you’re watching that may impact potential returns and alpha generation?
We are keeping an eye on interest rates. The fact that the U.S. 10-year bond yield has remained below 3% – very briefly going above that level – seems to have given the sector a psychological boost. NAFTA and trade barriers are another key theme. Currently, we see enough economic strength to overcome some trade noise, but we are obviously in a somewhat uncertain policy environment.
Q: How do you protect on the downside and mitigate risk for investors?
We believe we can mitigate downside risk by favouring sectors with strong fundamentals. This is why we continue to overweight multi-family, industrial and seniors housing. We remain biased towards REITs with quality assets, exposure to higher-growth markets, value-added development potential, as well as low payout and leverage ratios.
Strength Through Experience - Signature Global Asset Management's Real Estate Team
Senior Portfolio Manager
Lee Goldman has a successful long-term track record of managing real estate assets. He has been a lead manager of closed-end funds, mutual funds and exchange-traded funds since 2006. He joined Signature Global Asset Management in 2018 following 12 years as a lead manager at First Asset.
Kate MacDonald joined Signature Global Asset Management in 2018 as a portfolio manager responsible for a number of dedicated real estate funds, as well as real estate allocations across various strategies. Kate MacDonald has been co-managing real estate portfolios at First Asset since 2013 and her asset allocation decisions have been instrumental to First Asset REIT Income Fund and CI First Asset Canadian REIT ETF (TSX: RIT).
Joshua Varghese has been involved in global real estate investing since joining Signature in 2011, most recently as Portfolio Manager with responsibility for over $2.5 billion in global real estate assets across Signature funds. He is a frequent speaker at national real estate conferences such as RealPac and RealREIT. Joshua joined CI Investments in 2006 and has over 10 years of financial industry experience.
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