Two Chinese fund management firms are seeking to launch retail funds comprised of overseas real estate investment trusts (Reits) to provide what would be a novel new option for domestic investors.

Using their qualified domestic institutional investor (QDII) status, Lion FMC and Penghua FMC submitted applications to the China Securities Regulatory Commission last Thursday through the regulator’s innovative product channel.

Lion has broad coverage of developed markets, while Penghua primarily focuses on the United States. Both are aiming to capitalise on Chinese people’s fondness for investing in property, as well as the fact that the asset class is a popular hedge against inflation. China’s consumer price index rose 5.3% year-on-year in April.

Given that there are no Reits listed in China, these new funds would likely stir demand among retail investors seeking access to commercial real estate assets overseas, believes Gary Bi, managing director of international business and product management at Penghua. “We have confidence in the success of the new QDII fund,” he states.

With exchange-traded funds (ETFs) comprising overseas Reits readily available onshore in China, both FMCs opted to adopt active investment strategies for the new funds.

“Right after the global financial crisis, it was suitable to invest in a passive approach as the whole market rebounded strongly from a very low level,” reflects Bi. “But the market conditions have evolved. From now on, portfolio managers need to be selective.”

He notes that Penghua plans to select 30 to 50 Reits from the North American market, mostly the US, which boasts about 130 Reits, compared to 30 for Canada. These will be based on market cap, liquidity and performance of the underlying assets.

Meanwhile, Lion FMC’s director of product development, who preferred not to be named, notes that in terms of asset allocation strategy, the firm would seek to match the risk profiles of various Reits to appropriate economic cycles.

“In boom days, hotels and serviced apartments should perform well,” she explains. “However, as economic growth slows down, the portfolio may include more counter-cyclical real estate assets, such as healthcare centres.”

Bi notes that Reits have low correlation with traditional asset classes and offer better returns in the long term. According to the FTSE NAREIT Mortgage Reits Index, the long-term yield of Reits over the past 30 years is 11.87%, compared with 10.72% for S&P 500 over the same period. At the same time Reits provide two streams of revenue: capital gain and rental income.

Although the US property market has rebounded from historical lows over the past two years, Bi believes the valuation of its target Reits is still at a reasonable level. “The price of the underlying assets still has room to go up, backed by the continuously improving US economy,” he says, adding that investors can expect to achieve annual returns of 6-8% from rental income.

The Lion executive stresses the significance of rental income in reducing the volatility in Reits. “In the US, 90% of the net income of Reits is required to be paid out as dividends,” she points out. “Therefore, even when the economy weakens, the relatively stable revenue of some hospitals and healthcare centres can still ensure investors meaningful returns from income.” 

In terms of Penghua’s US-centric geographic focus, Bi explains that the US accounts for over 40% of the global Reit sector’s market cap.

“There is a more clearly defined legal and tax system and best corporate governance structure in the US which enables investors’ interests to be maximised,” he adds. “For instance, I believe hotel and resort Reits should perform well in the future as there is significant inflow of foreign tourists into the US to take advantage of the weak dollar.”

Lion FMC says it will also invest in other developed markets such as Europe, Australia and Hong Kong.

Neither company has decided whether to employ foreign advisers for their pending QDII funds. “We recently recruited an analyst dedicated to the new fund and have been contemplating hiring a foreign adviser to sharpen our insights and knowledge of the market niche,” adds Bi.