Market Commentary as of 6/30/08
Short-Lived Rally
The rebound in North American property returns during the first quarter of 2008 proved short-lived as the Fund underperformed its MSCI US REIT Index benchmark during the second quarter. Canadian REITs fared better than REITs in the US, finishing in slightly positive territory with a total return of 0.2% for the quarter. Overall, while average property returns of -3.4% thus far in 2008 have been less than inspiring, they have stacked up well against broader indices such as the S&P 500 and NASDAQ which have both produced double-digit losses for the year.
Self-storage and Apartments continue to be the top performing property sectors for the year in the US. Large operator Public Storage, which is up some 11.5% for the year-to-date, dominates the storage group, though all companies in the sector produced strong positive returns during the period. Although the slowing economy has not yet materially affected the sector, we think it is likely to in the future as individuals reduce their discretionary spending. Apartments continue to benefit from the availability of relatively low-cost debt that has facilitated several large transactions. Strong demand, reasonable valuations, and favorable spreads between renting versus owning remain positive factors, outweighing in our view negatives such as slowing fundamentals, supply concerns (especially in the form of condos and single-family rentals), and slowing job growth. We added a bit to our overweight position in Apartments during the quarter.
While we decreased the stake to Canada during the quarter, the Fund remains overweight relative to the index. We like the comparative stability of the Canadian marketplace in general, though we are finding limited opportunities for new investment at present given the benign growth prospects for a number of Canadian companies. That said, the Canadian economy continues to be healthier than that of the US, especially in the resource-driven Western Provinces, though it's likely that the weakness in the US, a dominant trading partner, will eventually have some affect on Canada.
One of the Fund's largest overweight positions is in the Retail sector, especially malls, which we increased throughout the quarter. Despite the negative sentiment surrounding the group in light of stressed consumer spending and slowing store sales growth, we like the long-term nature of mall leases, the lack of meaningful new supply, and the continued healthy demand for top-quality mall space from tenants. All the mall names held in the portfolio possess “A” quality portfolios.
Some Positives
The prospects for property shares have been, and will continue to be, shaped largely by the economic downturn and the credit markets. The group is likely to stagger along going forward until the depth and breadth of the current economic and financing malaise becomes clear. Capitalization rate expansion poses another risk for the sector as values typically decline as cap rates rise, which they have done recently. Still, cap rates are well below their historic averages, and the slowdown in transaction activity and wide spreads between buyers and sellers makes the determination of the appropriate cap rates to use in net asset valuation (NAV) calculations a bit difficult.
On the positive side, an overwhelming majority of publicly traded real estate companies possess healthy balance sheets. Given this strength, many companies should be well positioned to capitalize on the more attractive pricing that is likely to present itself at some point. In addition, while operating fundamentals continue to weaken, they remain at levels that promote positive—albeit slowing—earnings growth. The fact that overall supply levels are healthy, though not excessive, and seem likely to remain so given the current lending environment is positive as well. All of which should hedge against further declines in demand as the economy stumbles along, and position the industry well for a quicker recovery.
As of June 30, 2008, Public Storage comprised 7.64% of the portfolio's assets.
Note: Real Estate funds may be subject to a higher degree of market risk because of concentration in a specific industry or geographic sector. Risks include declines in the value of real estate, general and economic conditions, changes in the value of the underlying property and defaults by borrowers.
The views expressed above are for informational purposes only and is not intended as investment advice. Since the date of the commentary, economic, market conditions and the portfolio manager's views may have changed. Holdings and weightings are subject to change daily. Holdings are provided for informational purposes only and should not be construed as a recommendation to buy or sell the securities mentioned.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.