Perhaps it is just me but the world feels like an even more uncertain place than normal.
We have had natural (and far from natural) disasters, turbulent capital and commodity markets, negative interest rates, and now the small matter of an EU referendum.
Enough has been written on this last topic to fill several libraries, so I hesitate to wade in. But there is one element that in my view has not had enough attention, and has a broader relevance in any event, and that is how to build resilience to protect against events like this, whether they are foreseeable or not.
We are firmly in support of the UK remaining in the EU as we believe it is in the best interests of our clients, our employees and our business. However, the outcome is uncertain and there are things investors can proactively do to cushion their portfolios from the effect of downside risks, whether they emerge from known events (like Brexit) or unknown ones.
For illustration, let’s take two imaginary portfolios, each with £1bn of equity. One is invested in five office assets in the City of London, levered at 50%.
The other is a balanced portfolio made up of 10 different assets in a variety of strong locations (both in London and the UK regions) representing all the major property sectors, with 20% leverage.
Which would be the least adversely affected in the case of Brexit? We would argue it is the latter, diversified and conservatively levered portfolio.
Yes, the former may have done well in recent years but how well positioned is it for the long term, given that City offices is historically one of the most volatile sectors in world property?
Even without Brexit, the first portfolio may underperform in the near term. Before the referendum took centre stage, there were already signs of a slowdown in central London. On the other hand, we see potential for strong rental growth in regional offices, with the South East commuter belt and major cities like Manchester and Birmingham attracting growing interest from occupiers.
Beyond traditional real estate, there is a growing pool of residential and alternative investment opportunities, from private hospitals to student housing, much of which has defensive characteristics.
My point is that sometimes not enough thought is given to careful portfolio construction and it is at least as important as stock selection and asset management.
In particular, central London and the UK can occasionally be conflated in overseas investors’ minds. By concentrating on income-producing, high-quality assets in good locations, diversified across geographies (be that within the UK or globally) and sectors with prudent leverage, returns at the portfolio level can be more stable and reliable.
Clearly, this is not a short-term solution to deal with referendum risks. There are now less than two months to go until the vote, so for portfolios that are not already well diversified, there may not be scope to rebalance.
Even if, as we hope, ‘Bremain’ wins the day, this could be a wake-up call for the future.
In the end a balance needs to be struck; excessive conservatism can result in mistakes too. Portfolios need to be adjusted over time both to take advantages of opportunities and to mitigate known risks, while maintaining a broadly diversified exposure to guard against the unknown. Just at the moment, the waters feel choppy and the headwinds have been building. Brexit is either a gathering storm or a passing squall.
Whichever it is it seems to us an opportune time to batten down the hatches and portfolio resilience is the place to start.
Alex Jeffrey is chief executive, M&G Real Estate
