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The art of balancing investments to achieve maximum gain with minimum exposure to risk can be a complicated and delicate task. Here we briefly delve into the so-called investment science of ‘portfolio theory’.
The theory is one that continues to guide many of the investing principles that the industry applies on a daily basis. In a nutshell – and this is a greatly simplified explanation – portfolio theory contends that investments should not be selected on their individual merits alone. Rather, part of the criteria used to choose investments should also be how they relate to each other. That is, how they work as part of an overall portfolio.
Ultimately, this is the thinking that drives many advisers and investors to choose a range of different investments that each perform differently and have different risks associated with them.
The aim is to create a portfolio that, when aligned with the risk profile of a particular investor, can provide the highest possible return.
Property funds come in all shapes and sizes
The direct property funds managed by Australian Unity Investments are an important part of many investors’ portfolios, generally providing regular income distributions and the potential for good capital growth. But even within the many property funds on offer, there are some very interesting differentiating characteristics.
While all property investment will naturally share similar dependencies on things like interest rates, most will have distinguishing features. Some of these individual character traits are obvious. Our Retail Property Fund invests in the property associated with retail activities, such as shopping centres. And our office and industrial funds similarly invest in properties relating to their sectors. |
But regardless of their unique characteristics, the performance of each of these funds is still broadly dependant on the prevailing economic mood of the day and the investment sentiment for the commercial property investment generally.
Perhaps the most strikingly different fund in our property offering is the Healthcare Property Trust. The difference is due to the specific assets in the healthcare sector, the types of tenants it attracts and the unique environmental factors in which it operates, not least of which are Australia’s ageing population and ongoing Government funding commitments.
Historically, the performance of healthcare property has been more stable than other property sectors, even when confronted with something like the GFC. This is one of the reasons the sector continued to be popular with investors over the last three years.
Healthcare property can be good for your portfolio
Our Healthcare Property Trust invests in assets such as acute medical hospitals, rehabilitation hospitals, medical centres and aged care facilities (nursing homes). One of the features of these types of assets is that they are typically more resilient in the face of economic downturns.
Some of the reasons why healthcare assets don’t generally experience extreme market volatility are:
- scarcity of the assets and the difficulties developing new assets
- incentives to Australians to take up private healthcare from the Federal Government
- committed Government funding for healthcare services
- increasing demand for healthcare services as a result our ageing population.
Underpinning the entire healthcare industry is the enormity of funding provided by governments. For example, in the four-year period from 1 July 2008 to 30 June 2013, the Federal Government was forecast to spend $64 billion in the hospital and health system.
Additionally, health spending accounts for around 25 per cent of state and territory budgets.
Looking to our future healthcare needs, it’s a well-known fact that Australia’s population is rapidly ageing. The cause of this was the significant rise in Australia’s birth rate between 1946 and 1961. Since 1997, the first of the baby-boomers have been passing age 50 and entering age groups with significantly higher healthcare needs. Subsequently, between 1997 and 2006, the population aged 50–64 years increased at a higher rate than the population aged 65 years and over. And between 2006 and 2011, the population aged 60–64 increased at the highest rate (26.9%) of all age groups. At the end of the current 2011 year, the population aged 65 years and over is forecast to grow even faster.
With these facts in mind, it’s not hard see why the demand for healthcare services is expected to increase significantly over the next 25 years. This demand can benefit investors in the healthcare property sector.
A question of correlation – healthcare assets stand alone
Correlation is a measure of how much something moves or reacts in the same way to something else. In the case of investments, it is often interesting to see how the performance of a particular fund correlates against the broader industry in which it operates.
Active fund managers, such Australian Unity Investments, focus all of their activities on outperforming the industry average. So understanding how the performance of different property funds and how this performance correlates to the broader industry can provide some valuable insights on how to construct investment portfolios.
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The diagram to the right shows the level of correlation coefficient of the Healthcare Property Trust with the Investment Property Databank/ Property Council of Australia (IPD/PCA) Composite Index from March 2002 to September 2010. It also shows the relevant sector indices for retail, industrial and office property against the same composite benchmark.
A correlation coefficient of 1.00 would mean that two things move in sync with each other. As the chart shows, there is a very strong correlation between each of the well-known sector indices for retail, office and Industrial property against the broader composite index. Against the broader property market, however, the Trust shows a relatively low correlation, highlighting the Trust’s distinctive characteristics.
What this means for investors is that the Trust is likely to perform differently to other property sector-specific funds. And, perhaps most importantly, these differences do not come at the expense of more risk or lower returns.
Investors and financial advisers, then, can use information like this to combine different assets in a portfolio to create a return profile with better returns at a given level of risk.
Fine tuning a high performance investment
The aim of any investment portfolio will be to blend assets to reduce individual risks while still maximising returns.
As we already know, property has unique investment characteristics that warrant its inclusion in many investment portfolios as a separate asset class. However, diversification doesn’t have to end there. Diversification within a specific property allocation has the potential to further improve the mix.
If we think of investment performance as the engine of wealth creation, the inclusion of the Healthcare Property Trust might just be the fine tuning required to reach your client’s financial goal ‘finishing line’ faster and get the most out of your investment.
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