Market Commentary as of 12/31/09
US property stocks ended the year strong, with the Fund's MSCI US REIT Index posting a return of 7.1% for the month of December alone, in pushing fourth quarter returns to 9.1% and total returns for 2009 to 28.6%. The Fund slightly outperformed the benchmark for both the quarter and the full year. As the portfolio typically invests a small amount in Canadian property stocks as well, it is worth noting that Canadian returns also continued their stellar year, with the Canadian REIT Index producing a total return of 7.3% in during the fourth quarter and 55.3% for the year.
The strong returns during the fourth quarter in the US were due largely to a continuation of the positive factors that have unfolded throughout the year, including an improving macro-economic backdrop and a much improved credit market (including the re-emergence of the unsecured market). Much improved balance sheets across the industry on the back of roughly $20 billion in new equity issuance and the belief that many REITs may well be able to add to their growth prospects via acquisition opportunities aided performance as well. The Canadian economy, housing market, and credit markets have fared much better than the US during the economic downturn and similar to the US are now seeing an improving macro backdrop and improved balance sheets.
The Fund's outperformance was driven almost entirely by stock selection. A quality bias influenced that positive stock selection as several large overweight positions in the portfolio, such as Douglas Emmett, Simon Property Group, and Federal Realty Investment added meaningfully to performance. These names, along with a number of other portfolio holdings, tend to be the higher quality companies with very strong management teams, healthy balance sheets and a lower cost of capital relative to many of their peers. Likewise, the avoidance or underweighting of some of the lesser quality companies contributed to relative performance.
Portfolio Activity
From a sector perspective, there were several weighting changes of note. We further decreased the portfolio's weighting in Apartments on a combination of less appealing valuations coupled with a negative stance on the sector's near- to intermediate-term fundamentals, namely high vacancy rates and recent significant job losses. The overweight stake within Shopping Centers lessened as well, though that was driven at the company level as we trimmed the portfolio's overweight position in Kimco Realty as relative valuations became less appealing. Conversely, we increased the Fund's overweight position in the Industrials sector. Although operating fundamentals are weak across all sectors, we expect Industrials to be early beneficiaries of an improving economy as goods begin to move again given low inventory levels.
From an individual security standpoint, we added several "blind-pools" companies to the portfolio during the quarter. Blind pools refer to companies that do not own any properties currently, but have raised capital for building a portfolio through acquisitions. Pebblebrook Hotel Trust and shopping center company Retail Opportunity Investment are two such firms that the portfolio purchased. Although not typically the types of entities we might invest in, these two companies come with highly regarded and proven management teams that formerly headed up public REITs that we have owned in the past.
Outlook and Strategy
Valuations for both US and Canadian REITs have become less attractive given the strong returns experienced since their early March lows. Positive sentiment persists, however, for the property sector as evidenced by the significant capital raising done throughout the year and investors' apparent appetite for such deals. REITs should largely benefit from the highly-leveraged properties (many of which are in private hands) that have the means to acquire at accretive spreads to their cost of capital, thereby gaining further efficiencies of scale as they absorb such properties onto their existing operating platforms.
We continue to maintain more of a bottom-up than a top-down bias, though both factors are interrelated to a large degree. While the bottom up process tends to drive the portfolio makeup, the portfolio does harbor a few meaningful sector biases. We continue to maintain a relatively large underweight position to the Multifamily sector, where prospects look especially difficult in the near- to intermediate-term. Healthcare remains as the Fund's largest underweight. We still find valuations unattractive for the sector overall, a sector which witnessed strong outperformance in each of the previous two years.
Overall, we continue to favor the higher quality companies with proven, cycle-tested management teams, strong balance sheets and thus substantially lower cost-of-capital. These firms should find themselves rewarded given acquisition opportunities that are likely to present themselves over the next few years.
Fortis Investment Management
As of December 31, 2009, Douglas Emmett comprised 4.06% of the portfolio's assets, Simon Property Group – 13.64%, Federal Realty Investment – 5.45%, Kimco – 4.34%, Pebblebrook Hotel Trust - 0.47 %, and Retail Opportunity Investment – 0.44%.
Note: Real estate funds are non-diversified and may be more susceptible to risk than funds that invest more broadly. Risks include declines from deteriorating economic conditions, changes in the value of the underlying property, and defaults by borrowers. Investing in foreign markets also entails the risk of social and political instability, market illiquidity, and currency volatility.
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.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by PFPC Distributors, Inc.