Market Commentary as of 3/31/08
Despite a healthy dose of negative sentiment, global property markets were relatively flat during the quarter. Global growth expectations continue to trend downward, however, as uncertainty and volatility deriving from the ongoing credit crisis is likely to persist going forward. Economic concerns in North America increased amid speculation that the US was in the midst of a recession. While the economies of Europe are generally healthy in the major markets, growth expectations are slowing, inflation remains at an elevated level, and the European Central Bank has been hesitant to cut interest rates—dampening short-term sentiment. Headwinds in Asia are also providing a challenge. Although we like the long-term prospects of the region, countries have not been able to "de-couple" from the U.S. economy as vigorously as anticipated just a few short months ago. Given the differing expectations, the Fund has shifted assets out of the Americas to Europe, while remaining underweight Asia Pacific.
The Americas
Following a poor 2007, North American property returns bounced back into positive territory during the first quarter. The Fund underperformed its Global Research Property (GPR) Net 250 Index benchmark in the region as its largest overweight position in Canada, Boardwalk, significantly detracted from performance. In addition, US allocations to the Office and Apartment sectors hurt returns, with Office companies Kilroy, SL Green and Brookfield among the losers along with Apartment holdings Equity Residential and UDR. Offsetting some of those declines were gains in Retail companies Developers Diversified and Taubman, as well as Public Storage in the Storage sector.
Although equity investors are returning to the market to take advantage of good valuations, we shifted 2% of the fund's assets out of the Americas in bringing the Fund's allocation down to neutral versus the benchmark. We continue to like the relative stability of the Canadian marketplace in general, though volatility has certainly increased there as well. While the Canadian economy continues to be healthier than that of its neighbor, weakness in the US economy will have a spillover effect into Canada given that the US is their dominant trading partner.
We significantly decreased our Office exposure in favor of Apartments, by adding Post Properties to the portfolio and increasing the stake in Equity Residential. We soured on the Office sector due to its heavy leverage to the struggling US economy, with the selling PS Business Parks and Brookfield Properties. The Apartment sector possesses something that other sectors are sorely lacking—liquidity. Government sponsored agencies Fannie Mae and Freddie Mac continue to have adequate capacity and a strong appetite to finance multi-family transactions with favorable terms. The availability of this low-cost debt has helped to keep capital rates relatively low for the group, and has facilitated large transactions. Furthermore, we significantly increased the portfolio's weight in the Healthcare sector with the addition of Nationwide Health Properties.
Europe
Of the main countries in the benchmark, Switzerland, Finland, Belgium and France performed the best throughout the quarter with returns in excess of 5%. The Fund slightly underperformed in the region owing to country allocation, as stock selection was positive—especially in Austria, France and the UK. Underweight positions in Switzerland and Belgium, as well as an overweight stake in UK, detracted the most from performance. The weakness in the UK owes mainly to the decrease in the Pound relative to the Euro.
We increased the portfolio's weighting in the region to where it is now overweight the benchmark by more than three percentage points. We continue to favor the UK market, believing that with its attractive valuations it offers the biggest upside potential in the region. Save for the faltering Pound the UK property market was strong during the quarter. The fundamental data still supports future earnings growth, and the increasing prospects of a lower interest rate environment should benefit the real estate market. Elsewhere in Europe, we are positive on Finland and France. Finland has a strong economic outlook with rental upside potential and proximity to Russia to benefit from that emerging market. We prefer France for fundamental and stock specific reasons and remain underweight Belgium and Switzerland, reflecting the limited growth potential in these markets.
Asia-Pacific
Key underweight positions in Japan and Hong Kong surpassed expectations, which along with overweight positions in Australia and Singapore contributed to superior relative performance in Asia-Pacific. While all markets in the region were down, the Fund's country allocations were such that we were able to minimize exposure to the lagging areas. Singapore proved to be the least negative country on the back of a strong showing from Capitaland and CapitaMall, both of which were overweight positions in the portfolio. Although we like the long-term characteristics of the region, increased volatility and uncertainty in the global markets does not warrant an overweight position.
Despite anecdotal evidence of slowing rental demand in the residential market affecting sales, we're maintaining our positive view on Singapore. A residential pullback would not be an altogether bad thing in a market that has seen outsized gains. Rental demand in the Office, Retail and Industrial sectors, on the other hand, continue to soar. We remain convinced that the macroeconomic effect of the large expected lift in population will underpin earnings and growth for the next several years. Elsewhere, we have become skeptical of Hong Kong and Japan. The Fund has also slowly moved from an underweight to an overweight position in Australia, where strong fundamentals present more stability.
We made a number of changes to the portfolio driven by the decision to allocate away from Japan. Our concern stems from the upcoming Japanese reporting season, and the suspicion that Japan may not prove immune to the global credit crunch. Thus, we trimmed the Fund's stake in all of its current Japan holdings, plowing the proceeds into two new Australian companies, ING Office and Mirvac Group.
ABN AMRO Asset Management
Chicago, IL
Note: Risks of international investing include but are not limited to social and political instability, market illiquidity and currency volatility. The Fund is non-diversified and may be more susceptible to risk than funds that invest more broadly. Real estate funds may be subject to a higher degree of market risk because of changes in property values 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.
As the fund is actively managed, the securities as presented do not represent the current or future composition of the portfolio.
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.