At the start of 2020, few of us had heard of a coronavirus. That changed in early March when the World Health Organisation deemed the COVID-19 outbreak a global pandemic. After markets peaked in late February, a rapid and unprecedented sell-off ensued. The Australian 300 equities index fell 20.8%1 while the AREIT 300 index declined a staggering 35.2%2, the second-worst performing sector behind Energy which was down -37.5% in one month. The sell-off was unparalleled.
It wasn’t only investors that were panicking. Supermarket queues highlighted the desperation. With investors facing nauseating levels of volatility, it was hardly surprising that toilet paper was the big-ticket item!
The performance of AREITs in March was a shock, the decline exceeding by 10% the worst previous fall in October 2008. Whilst Australian REITs were down by over a third, Global REITs fared better, falling by -20.1%3 with Asia the standout, down a mere 15.4%4.
The Australian REIT market reaction was extreme. Inflaming the sell-off were the sector’s high retail exposure, double that of most offshore markets (31% vs. 16% globally). COVID-19’s spread and the lockdowns it provoked put retail in the gun sights. Retail REITs plummeted over 46% in March lead by the large mall landlords Scentre Group (-54.8%) and Vicinity (-52.1%), dragging the AREIT market down with them.
Due to the sector’s relatively high distribution yield, Australian REITs have traditionally been a happy hunting ground for offshore investors. When the virus hit, though, many ran for the hills, encouraged by the Australian dollar reaching a low of USD$0.55.
With the world facing an unprecedented health and economic disaster, central banks undertook wide-ranging measures to counteract the adverse impacts. The RBA cut rates twice in March to what was then a record low of 0.25% and governments embarked on major stimulus packages, including widespread income support for those facing extended lockdowns. The world as we knew it changed rapidly and remarkably.
How APN responded
At APN, our response was to actively reposition the portfolio early in the crisis. Many countries were suffering from the impacts of the pandemic before it hit Australia. That allowed us to evaluate the impacts overseas and make portfolio adjustments before it fully hit home. The first was to accumulate as much cash as possible to protect investor capital. At the end February the Fund held 3.3% cash which may not sound much but our long-term target is 1-2%. Through March the Fund reached its maximum cash position of 10%, finishing the month at 8.2% as we began redeploying proceeds as the market stabilised. By the end of April, we were back at 3.3%, with cash further reduced to our long-term target range (1-2%) over recent months as we sought to maximise our exposure to the market as pandemic concerns diminished.
In commercial real estate, there was a clear pecking order of impacts. Tourism, or the absence of it, was at the top of the queue. Whilst Australia lacks dedicated listed hotel REITs, all hotel chains have been badly affected. Retail was next, although the impact varied with property type. Convenience and large format retail, for example, suffered less than shopping centres, and in some cases prospered.
The same variation can be seen in the office sector. With central business districts almost empty, city centre offices suffered more than metropolitan locations. But with people working from home and unable to spend in restaurants, cinemas and other places, online shopping boomed, making industrial REITs the most defensive play.
On reflection, it’s incredible to see how quickly the history and quality of a stock was thrown out the window. The primary focus of investors became a game of trying to work out how each sector was going to survive COVID-19, with retail losing heavily, office less so and industrial the clear winner.
That’s easy to see in retrospect but at the time no one could say for sure it was going to play out that way. Without a knowledge base about the impact of a pandemic, very early on we set about building one. This allowed us to make some key portfolio changes, without moving too far away from the Fund’s investment objectives.
Chart one highlights the adjustments we made by real estate sector type over the past year. Most notable is the change in our exposure to retail, which was reduced from 55.8% of the fund to a low of 34.1% in July. The non-discretionary component of our remaining retail exposure grew to almost 60% due to our belief in the defensive cashflows of these assets. The release of these funds allowed us to increase our exposure to industrial and specialist REIT sectors which were to prove far more defensive through COVID. We have had to adapt to this rapidly changing environment thus as our confidence in the re-opening trade has grown our retail exposure been increased (39.0% by the end of November). One cannot sit still for long!