Prime property scores highly on
- Location
- Age and condition
- Quality of tenant
- Number of comparable properties
- Lease structure
- Size
Flaws of Direct Property holdings:
- Size: many properties are too large for most investors to afford
- Diversification: many properties are needed to create a well-diversified property portfolio. The size of each investment might make this impractical for smaller funds and individual investors.
- Lack of Marketability: the time and costs associated with buying and selling make properties unmarketable.
- Valuation: property values are never known until sale. Estimates of values can be expensive.
- Expertise needed: much of the profit to be made through property investment comes through detailed local knowledge. Many investors will not have the specialist expertise.
Property shares stand at a discount to their underlying estimated NAV. The discount to NAV reflects:
- Possible capital gains tax on liabilities
- Market valuation of holdings differing from the valuations underlying the NAV – this arises because of the lack of current quoted prices on property, with valuations being subjective and based on historic information
- Risk of loss on forced sale – cashflow requirements result in property companies being more likely to be forced sellers of properties than institutions undertaking direct property investment on their own account.
A smaller discount, or possibly even a premium, to NAV is possible where:
- The market has a positive view of developments giving the potential for capital gains
- The valuations underlying the NAV are conservative
- The property company has a good management track record.
Main features of OEICs:
- They are companies governed by company law, as opposed to trusts, like investment trust companies. However, they can create and cancel share capital at will – i.e. they are open-ended like unit trusts
- They have limited powers to borrow (i.e. gearing)
- A single company can offer several different funds. Only one corporate structure is required, however, unlike unit trusts where each fund has a separate status (as a trust). Thus the investor first chooses which OEIC in which to invest and then chooses the fund or funds within that OEIC in which to invest.
- This should reduce the management costs as compared to unit trusts – i.e. as part of the management costs are effectively spread over several funds.
- The restrictions on the assets in which OEICs may invest are the same as for unit trusts – i.e. in tradable securities as defined under a European directive.
- There is a single price for both buying and selling, which is equal to the net asset value of the underlying investments. All charges and commissions are shown / deducted separately. This offers greater transparency to investors.
Differences between closed-ended (investment trusts) and open-ended (unit trusts) funds:
- The marketability of the shares of closed-ended funds is often less than the marketability of their underlying assets. The marketability of units in an open-ended fund is guaranteed by the managers.
- Gearing of closed-ended funds can make the shares more volatile than the underlying equity. Most open-ended funds cannot be geared and those that can may only be geared to a limited extent. This increases the volatility of closed-ended funds means that they should provide a higher expected return.
- Shares in closed-ended funds are also more volatile than the underlying equity because the size of the discount can change. The volatility of units in an open-ended fund should be similar to that of the underlying assets.
- At any point in time there may be uncertainty as to the true level of net asset value per share of closed-ended funds, especially if the investments are unquoted.
- Management charges are usually higher for open-ended funds than closed-ended funds.
- Closed-ended funds may be able to invest in a wider range of assets than unit trusts.
- It may be possible to buy assets at less than the net asset value in a closed-ended fund.
- They may be subject to tax at different rates.
Differences between Indirect vs. direct investment:
- Control
- Diversification
- Expertise and specialisation
- Expenses
- Marketability
- Taxation
- Expected returns and risk
- Gearing
- Discount to NAV
- Volatility
- Individual investment products
Advantages and disadvantages of collective investment vehicles/schemes:
Advantages (greater for small investors than for large ones):
• They are useful for obtaining specialist expertise
• They are an easy way of obtaining diversification
• Some of the costs of direct investment management are avoided
• Holdings are divisible – part of a holding in any particular trust can be sold
• There may be tax advantages
• There may be marketability advantages ( but they may also be less marketable than the underlying assets)
• They can be used to track the return on a specific index (index tracker funds)
Disadvantages:
• Loss of control – the investor has no control over the individual investments chosen by the managers
• Management charges are incurred
• There may be tax disadvantages such as withholding tax, which cannot be reclaimed
Why invest overseas
- Match liabilities by currency
- Diversification
- Greater return
Why would overseas investments have greater returns
- Undervalued markets
- Strengthening currency
- Higher risk or fast-growing economies
Drawbacks of overseas investments
- Liabilities mismatched by currency
- Currency movements cause additional volatility
- Cost of obtaining expertise
- Cost of/need to appoint overseas custodian
- Additional administration
- Repatriation problems
- Different accounting standards/methods
- Lack of good quality information
- Language problems
- Possible time delays
- Poorly regulated markets and political instability
- Political risks
- Possible lack of liquidity and quality information
- Restrictions on ownership of certain shares by foreign investors
Indirect overseas investment may involve investing in
- Multinational companies based in the home market
- Domestic companies with sufficient export trade
- Collective investment schemes specialising in foreign investment
- Derivatives based on overseas assets
Factors to consider before investing in emerging markets
- Current market valuation
- Possibility of high economic growth
- Currency stability and strength
- Level of marketability
- Degree of political stability
- Market regulation
- Restrictions on foreign investment
- Range of companies available
- Communication problems
- Availability and quality of information
- Withholding taxes that apply
- Expertise in the market
- Extra cost, eg custody fees
- Extent of additional diversity generated
