Aberdeen’s property business is by and large a core one, catering to those who want property to offer relatively simple things: a durable income stream, the potential for long-term income growth and some diversification away from other asset classes.
Our investors are not looking for property to deliver double-digit returns. Nonetheless, there have been quite a few good years of returns from UK property now – values are 42% higher than the trough in 2009, according to the IPD/MSCI Monthly Index.
In London’s Midtown/West End office market they are 135% higher than the trough in 2009 and 29% higher than in the peak of 2007. Things have turned out well, at least for some parts of the market. If you agree that this cannot last forever, then it must stop. When? That’s the question I am most often asked. The answer? I don’t know.
But knowing that it can’t last forever, what should you do? Enjoy the ride or try not to lose the money you have already made? A focus on returns, while fun, would suggest the former and a focus on risk, which is more boring, the latter.
Having good risk control in place looks pointless when the market is rising but is useful when it falls; the problem is that you have to have the risk control in place when the market is rising so that it pays off when the market falls.
How to manage risk
You can manage risk but you can’t manage returns, so, selling risk (assets that the market is prepared to pay too much for given their fundamental characteristics) when the market is rising and holding a low-risk position (and buying quality cheap) as the market falls should mean either higher returns for the same level of risk or, better still in my book, the same level of returns for lower risk. Delivering a target return for lower risk than it requires appears much under-rated, whereas the search for alpha returns is perpetually seen as the holy grail.
The biggest risks for us are relatively straightforward: buying or holding poor-quality properties or overpaying for good ones. Unlike our counterparts in the stock market, we can’t press a button and sell if we make a mistake, so taking our time to work out what we are investing in is very important.
For long-term investors like most of our clients, probably the biggest risk right now is being fooled into thinking a poor-quality property is a good-quality property. The easiest way to be fooled is to focus on longish leases to reasonable covenants on recently let property in marginal locations that has been refurbished and is now in the best position this asset is likely to be for the next ten years.
At the end of that lease, will it go round the loop of being unable to let, being sold, then refurbished and let to a reasonable covenant on a longish lease?
Risk is a strange concept and when you don’t experience it, it doesn’t seem important to take notice of the possible outcomes that didn’t happen. And the more this goes on, the less likely you are to take note.
Think of risk management as an insurance policy. We all try to avoid risks in the first place, so we lock the doors when we leave our house, turn on the lights, turn the water off when we are on holiday or maybe even install a burglar alarm. But ultimately we take out insurance and sacrifice some fun by spending money on insurance because whatever we do, some risk may materialise.
If we don’t get burgled or have a water leak for five years, do we cancel the insurance policy? No. Sacrificing some of the upside of performance for an insurance policy for when markets fall seems like a piece of insurance we ought to have in place, all the time.
Negative outcomes
Relentlessly experiencing the negative outcomes of risk taking is likely to reset the mind to be wary and to appreciate better the full range of possible outcomes. This reset is likely to take the form of managing risk but is all too hastily forgotten once the risks don’t materialise. I am sure there are plenty of orthopaedic surgeons that ski but I suspect they manage the risks very well and have good insurance policies. With the skiing season in full flow, you might get to ask one about their approach to risk sooner than you think.
Russell Chaplin is chief investment officer, property, Aberdeen Asset Management
