Real estate investment trusts (Reits) are an increasingly attractive proposition for insurers in Asia as they are best placed to benefit from the disruptions fueled by Covid-19.

The asset class bears a large number of traits that include yield, diversity and environmental, social and governance (ESG) transparency, making them more appealing to Asian insurers.

Max Davies

 

“Reits are a compelling, long-term income generating tool. They help portfolios mitigate downside risk, making them a good fit for Asian insurers in a post-Covid world,” said Max Davies, insurance strategist at Wellington Management.

Recent structural changes in consumer behaviour have made certain real estate segments highly attractive. For instance, greater reliance on e-commerce for household items has in turn boosted further demand for data centres and warehousing.

Moreover, landlords remain in a strong position to maintain rental income streams given the resiliency of renters’ demand — even among brick-and-mortar retailers, many of whom have been severely impacted financially by the crisis yet typically sign long-term tenancy agreements.

It’s best to capture these opportunities in Reits, which are currently trading at a discount to the broad equity market based on long-term averages. The asset class can also act as a hedge against inflation, given that property prices generally increase over time.

The benefits of Reits are frequently overlooked by insurers. The rationale for investing in private real estate is that by forgoing liquidity, it is possible to increase the yield, overall return and diversification potential of the portfolio, but often these ambitions are not realised.

“Reits, however, typically attain these goals whilst retaining liquidity, irrespective of where they are domiciled,” he said.

Reits globally outperformed private real estate and every other asset class, except for private equity, between 1998 and 2018. Another noteworthy feature is low volatility, which is less than private equity and comparable to private real estate. This results in a risk-adjusted return that is more favourable than all asset classes, with the exception of US fixed income.

­­Reits globally outperformed every other asset class except for private equity in 1998-2018

Sources: CEM Benchmarking, Alexander D. Beath and Chris Flynn, “Asset allocation and fund performance of defined benefit pension funds in the United States, 1998 − 2018,” October 2020. | PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS AND AN INVESTMENT CAN LOSE VALUE.

LIQUIDITY AND DIVERSIFICATION

Insurers in the region are increasingly attracted to illiquid assets like direct real estate, real estate debt and mortgage loans in today’s low yield environment.  However, not only do these types of assets heighten liquidity risk, they could even result in higher capital charges, which further limit an insurer’s exposure to illiquid assets.

“Reits, by contrast, can provide daily liquidity with transparent disclosures, and greater diversification by region and sector when compared to private real estate,” Davies said.

Reits have always played a noteworthy role within a diversified portfolio. Analysis by Wellington has shown that over the past 20 years, a portfolio holding 60% Reits and 40% private real estate will have outperformed a portfolio that held 100% of private real estate by over 50 basis points.

For illustrative purposes only and not representative of any Wellington approach or actual investment. The simulations presented are hypothetical and not representative of an actual account. Simulated performance is developed with the benefit of hindsight (i.e., actual knowledge of market condition, result of similar strategies) and thus has many inherent limitations. Actual performance may differ substantially from the hypothetical presented. | PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS AND AN INVESTMENT CAN LOSE VALUE. | NCREIF and FTSE indexes used. Assumes unhedged exposure and portfolio allocations were made at inception and were rebalanced monthly. | Sources: Wellington Management, FactSet, FTSE. Chart data: January 1998 – March 2021

“A key reason for this is that Reits are generally more diverse, and usually include emerging property types such as cell towers, data centres, healthcare facilities, self-storage, cold storage and single-family rentals,” explained Davies.

“These assets are driven by demand trends different from traditional property types such as offices, apartments, retail and industrials, which make up the majority of private real estate.”

FAVOURABLE YIELDS AND CAPITAL TREATMENT

Due to the underwhelming income presently on offer from traditional bonds, some insurers have been looking to supplement their fixed income yields with income-producing equities - to the extent that their capital positions allow.

In this regard, Reits can offer an attractive natural investment income via their dividends, particularly when compared to the yields on offer in government bonds. As of July this year, the US Reit dividend yield is outperforming the US 10-year treasury by almost 3 percentage points, with the former yielding 3.6% versus the latter’s 0.9%.

US Reit Dividend Yield versus US 10-year Treasury, 1994-2020

Dividend yield average for CITI universe of equity REITs for each monthly period. | Sources: Citi Research, FactSet. Global Reits represented by Citi Research Global Equity Reit universe. | Higher yields of Reits come at a higher level of risk relative to US 10-year Treasuries, which are considered one of the safest investments, whereas Reits are subject to potential loss of principal. | PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. For illustrative purposes only. Not representative of an actual investment. | Chart data: 31 December 1994 – 31 December 2020

“Client demand for income-producing strategies is growing, as Reits following a global property-income approach can provide compelling yields and stable income generation,” Davies said.

He also noted that such an approach may be considered by insurers that are subject to International Financial Reporting Standards 9 (IFRS 9). The strategies have the potential to reduce earnings volatility if designated as “fair value through other comprehensive income” (FVOCI).

Interestingly, some of Asia’s regulatory regimes favour Reits over traditional equities in terms of capital treatment. Under the proposed Hong Kong risk-based capital regime, for example, Reits are classified as property investments and the resulting capital charge is a favourable 25%, if look-through analysis is conducted. In contrast, the capital charge is 40% for developed market equities, whereas it is 50% for emerging and private equities.

COUNTERING CLIMATE RISK

A further key benefit of investing in Reits is their in-depth disclosures and openness to high-level scrutiny by both investors and regulators. For ESG-conscious investors like insurers, this is significant.

Insurers can further enhance their oversight of climate risks by leveraging Wellington Management’s physical climate risk mapping tool, titled Climate Exposure Risk Analysis (CERA).

Developed in partnership with the Woodwell Climate Research Center, the tool facilitates overlays of climate variables — heat, drought, wildfires, hurricanes, floods, water scarcity, and air quality — onto geospatial maps that pinpoint capital assets and project their exposure to these risks over the longer term.

CERA’s geospatial mapping precision enables the firm and its insurance clients to understand in granular detail the physical climate risks associated with real estate investments. The tool also unearths a range of future climate outcomes on real estate assets, the companies that own them, and the sector as a whole.

Overall, given today’s burgeoning demand for new and conventional properties, as well as the asset class’s ability to deliver yield, diversification and ESG transparency, Asian insurers should strongly consider upping their interest in Reits as they seek to thrive in a post-Covid world.

Click here to learn more about why Reits are a good fit for Asian insurers.

This material is prepared for, and authorized for internal use by, designated institutional and professional investors and their consultants or for such other use as may be authorized by Wellington Management. This material and/or its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.