Ainslie McLennan, Co-Manager of the Janus Henderson UK Property PAIF, explains why the UK commercial property investment team feel vindicated in moving early to diversify the portfolio away from traditional areas of the retail market.

      Key takeaways:

• The fund’s investment team have long recognised that retail was a sector that would be disrupted by technology and shifting consumption patterns.
• As a result, the team have continued to diversify the portfolio, bringing down the standard retail weighting to 4.9% at the end of 2019 and seeking exposure to areas of the market that they believe are best suited to the conditions ahead.
• Asset management activities, such as refurbishment work, changing the planning use of assets to increase rental revenue, or renegotiating existing leases to extend tenancies, are methods that the managers can use to help improve rental and capital values within retail against a challenging sector backdrop.

We have long recognised that retail was a sector that would be disrupted by technology and shifting consumption patterns. The internet was generating opportunities for some areas of retail, notably logistics and experiential shopping, but creating a headwind for others. The list of high street casualties and companies forced into renegotiating terms with debtors and landlords is long.

That is why we have spent the last few years diversifying the portfolio, bringing down the standard retail weighting from an already underweight 13.9% at the end 2016 to 4.9% at the end of 2019, but also seeking to ensure exposure is to those areas that we believe are best suited to the market conditions ahead.

Retail diversification

As the chart below shows, just 4.9% of the Janus Henderson UK Property PAIF’s overall retail exposure is currently classified as standard retail, which includes traditional high street assets and public houses, nearly all of which is based in London. The remainder of the retail portfolio is invested in retail warehousing (15.0%) and single-let supermarkets (3.8%), as well as an outlet mall (3.8%).

Janus Henderson UK Property PAIF sector allocation by capital value 

Source: Janus Henderson Investors, at 31 December 2019. The sum of the sectors and cash may not equal 100% due to rounding The above example is intended for illustrative purposes only and is not indicative of the historical or future performance of the Janus Henderson UK Property PAIF.

Valuations

The fund’s balanced approach to investing across a variety of sectors and assets has meant that any capital losses from within the retail sector in 2019 were more than offset by gains made in other areas in which it invests, helped by asset management activities and income generation.

Positioning

The Janus Henderson UK Property PAIF has no exposure to shopping centres. This is an area which makes up a sizeable portion of some retail portfolios within the IA UK Direct Property peer group and one that experienced double-digit valuation declines over the year to the end of September.*

Most shopping centres are anchored by large department stores, which continue to be negatively impacted by the rise of ecommerce. This structural shift in the way we shop has driven valuation declines for certain areas of the retail sector. We acted early to position the fund away from this type of retailer a number of years ago and as a result there is no tenant exposure to the likes of Debenhams or House of Fraser.

The fund owns one outlet mall which operates very differently, is in high demand and has rent linked to the turnover. This asset has had year-on-year rental growth and has been a strong contributor to performance.

The fund’s positioning has been sensitive to changes in the retail market and some of the struggles in regions outside of London and the South East. Consequently, the fund owns only a very small weighting in absolute (4.9%) and relative terms to the high street and, importantly, has no tenant exposure to struggling retailers such as Mothercare, Monsoon, Topshop and Patisserie Valerie, which have hit the headlines for the wrong reasons.

Logistics and distribution

On the flip side of the retail restructuring, investors in the fund have enjoyed the benefits of owning high-specification and well-positioned logistical and distribution units. Demand for this type of asset has grown as retailers and consumers look for efficiency in how they acquire or deliver goods. We expect this trend to continue.

Feeding growth

The fund continues to maintain an overweight position to supermarkets. This was the only resilient retail subsector over the last 12 months that provided capital growth.* Valuations of supermarket-based assets have remained stable and those let to strong-trading tenants in good locations have seen gains. Food remains a relatively defensive sector and footfall in out-of-town supermarkets has also benefited from the convenience and accessibility for shoppers.

All of the fund’s supermarket stores have an average unexpired lease term in excess of 10 years and report strong trading. A significant proportion of this income benefits from inflation-linked rent reviews. The fund’s supermarket exposure experienced a capital gain of 15.7% against an MSCI peer group benchmark rise of 0.4%.* The strong outperformance was driven by our team’s asset management and sales in that sector. The lease on the Asda store in Hulme, Manchester, was extended to 20 years before being sold, which crystallised significant profit.

Elsewhere, a rent review increase helped boost the valuation for a Lidl supermarket owned in Croydon, South London.

Source: *MSCI UK Daily Traded APUT & PAIF UK Quarterly Universe Report, September 2019. Latest available data.

The Maltings, Salisbury. Source: Nuveen Real Estate Management

Asset management wins have helped drive up rental and capital values on some assets within the fund, including within retail. Asset management can include refurbishment work to improve valuations and attract a better quality of tenant, changing the planning use of assets to increase rental revenue, or renegotiating existing leases to extend tenancies. The following example provides insight into how our investment team can enhance returns:

• Planning permission has been granted for the construction of an 86-room hotel, gym and library on the site of a vacant retail unit in Salisbury, previously let to the British Heart Foundation.
• The hotel represents approximately 75% of the development by value and is pre-let to Travelodge for a term of 25 years with rental increases based on inflation linked to the Retail Price Index.
• The remaining ground floor units are both under offer to prospective tenants.
• The development is expected to complete late in 2020.
• Securing a binding legal agreement with a tenant for three quarters of the accommodation at this early stage of the development significantly reduces leasing and development risk and increases the amount of contractual rental income from tenants on long leases.

Discrete year performance

Source: Morningstar as at 31 December 2019. PAIF & Feeder Fund discrete year returns to 31 December, accumulation share class, bid to bid pricing basis, net of fees, in sterling terms. Peer group comparator is the IA UK Direct Property Sector average return. Performance data may change due to final dividend information being received after quarter end.

Peer group comparator: IA UK Direct Property. The Investment Association (IA) groups funds with similar geographic and/or investment remit into sectors. The fund’s ranking within the sector (as calculated by a number of data providers) can be a useful performance comparison against other funds with similar aims.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.