Paul Duncan, Catalyst Fund Managers
Taking a long/short approach to listed real estate can provide the kind of flexibility needed to negotiate turbulent markets, while diversifying both locally and offshore brings an added level of diversification. This is the view of the team at Catalyst Fund Managers Alternative Investments, who are specialists in the single asset class of listed real estate yet apply hedge fund tools to give added flexibility to both amplify returns and reduce volatility.
In addition, global real estate and local real estate are lowly correlated, which means that blending them together in a portfolio can deliver similar returns at lower volatility. Particularly in the last few years, this ability to diversify between local and global listed real estate has been critical to delivering on an absolute return mandate.
Further benefits can materialise from having flexible mandates to invest across multiple geographies and real estate sub-sectors, take long and/or short positions and utilise other risk management tools that other traditional funds are unable to take advantage of.
In short, investors with exposure to listed real estate can benefit from a long/short approach in a globally diversified portfolio.
Here’s what to look for:
Look for a capable and committed, co-invested team
The origin of the Catalyst Fund Managers Alternative Investments local and global hedge funds was driven by an objective to manage our own and fellow investors’ money in a fund structure which gave the management team the tools to express their best listed real estate ideas in an unconstrained and flexible way. The creation of the Catalyst Alpha Prescient QI Hedge Fund and the Catalyst Alpha Global Real Estate Hedge achieved this objective. These funds are managed by Andre Stadler, Paul Duncan, and Marcus Erlank who between them have over 50 years’ experience in real estate and financial markets. Managing these two funds is the team’s only focus and management remain material investors in the funds. An underlying principle of the investment philosophy is appropriately balancing the risk and return tradeoff. The mindset and behaviour that comes with managing our own capital alongside fellow investors underpins the commitment to this principle.
Look for a strong track record
The Catalyst Alpha Prescient QI Hedge Fund was launched in February 2006, making it one of the oldest hedge funds in South Africa. The fund is locally domiciled, and while it can invest anywhere in the world, it has over time always had a meaningful South African listed real estate exposure. The fund has delivered a total return of 17.46% per annum since inception, materially outperforming its three-month Jibar benchmark (7.03%), the SA listed Property index (9.09%) and the All-Share index (11.42%) over the same period. The fund has delivered this performance at significantly lower risk than these other equity-like indices.
Look for downside protection
The fund employs a long/short approach, which has given the team the flexibility to negotiate the turbulence of the local listed real estate market over recent years. The flexibility of the mandate and the management team’s ability has meant that the fund has been able to protect capital even during some of the biggest drawdowns in listed real estate in recent years. For example, in 2018 when the SA Listed Property index (SAPY) recorded a total return of -25.26%, the Catalyst Alpha Prescient QI Fund recorded a total return of +5.36%. In 2020 when the SAPY recorded a total return of -34.49%, the Catalyst Alpha Prescient QI Fund recorded a total return of +5.65%.
Look for a strong investment thesis
An underlying principle of the Catalyst Alpha Prescient QI Hedge Fund’s investment philosophy is that we believe that listed real estate, as an asset class locally, has the ability to deliver a total return that is driven by the free cashflow yield plus growth in that free cashflow over time.
In South Africa, we expect that internal rate of return to be somewhere between 11% and 13% in rand, underpinned by an approximate 9-10% free cashflow yield plus growth on that free cashflow of approximately 3-4% per annum.
Globally, we believe real estate fundamentally functions in the same way. The return drivers are the same. We would underwrite a free cashflow yield of approximately 4% plus 2% growth in free cashflow, which gives an approximate 6% internal rate of return in dollars. We also assume that, over time, the rand will depreciate. That depreciation is theoretically 4% to 5% per annum, which means that dollar returns of 6% from global real estate translate into a 10% or 11% return in rand. So, holding these two assets through time should deliver similar annual returns. However, global real estate and local real estate are lowly correlated, which means that blending them together delivers similar returns at lower volatility. Particularly in the last few years, this ability to diversify between local and global listed real estate has been critical to delivering on the local fund’s absolute-return mandate.
The Catalyst Alpha Global Real Estate Fund was launched in November 2015. The fund is domiciled in Ireland and is US dollar denominated. The fund has an approximate six-year track record and has since inception delivered an annualised total return (to August 2021) of 7.74% in US dollars, outperforming its three-month US Libor +3% benchmark (4.33%) and the FTSE EPRA NAREIT Index (6.75%).
Like the local fund, the tools available and flexibility of the mandate as well as the team’s ability has meant that the fund has also protected against drawdowns. In 2020, global listed real estate recorded a total return of -8.84% in US dollars. Over the same period the Catalyst Alpha Global Real Estate Fund recorded a total return of +7.31% in US dollars.
Look for solid research capability
The Catalyst Alpha Global Real Estate Fund currently only invests in developed markets. There are approximately 300 constituents in the EPRA NAREIT Index alone. The team does primary research on about 150 companies across multiple jurisdictions and sectors. The global property market comprises many different sub-sectors beyond the traditional retail, office and industrial as well as access to different geographical regions, all at different stages of the real estate cycle both from a real estate fundamentals and pricing point of view. The Catalyst team has decades of experience in listed real estate, with a focused research process that uses a bottom-up fundamental analysis on a company-by-company basis, while tracking the trends that drive the real estate sector, property portfolios and specific assets. It is this proven ability and process, the extent of the opportunity set and the funds’ flexibility that has allowed the team to deliver such strong absolute returns at low volatility since inception.
Look to preserve the opportunity set
The Catalyst Alpha Prescient QI Hedge Fund isn’t a strategy that is scalable to the point where you can have a very large fund with the opportunity set. The current AUM is approximately R450 million and we believe the fund is scalable to approximately R750 million. The Catalyst Alpha Global Real Estate Fund currently has AUM of approximately $36 million. The liquidity and opportunity set available in global real estate markets is larger, implying the capacity to grow the AUM of the Catalyst Alpha Global Real Estate Fund is greater. The combined AUM of the two funds is approximately R1 billion, and the management team are material investors in the funds. We are committed to creating an environment that ensures there are no distractions to achieving the best risk-adjusted returns for ourselves and our fellow investors. Our focus is on returns and not assets under management. To outperform and deliver that return, you need the flexibility.
Look for good ideas in a strong framework
Global and local listed real estate valuations look attractive, albeit with higher risk, especially locally. We have illustrated that we can manage this risk well. We have protected capital and delivered absolute returns in negative return cycles and have delivered strong positive returns in positive return cycles. In South Africa, the short-term outlook remains challenging and uncertain, but we see some very attractive longer-term opportunities. Globally, the breadth and depth of the opportunity set means there are both attractive long- and short-term investment opportunities. The funds are well positioned to take advantage of these risk-adjusted return opportunities. We have the tools at our disposal to take advantage of these opportunities and we will continue to do so, whilst maintaining a strict adherence to our investment philosophy. Copyright. HedgeNews Africa – November 2021.
Paul Duncan is a director and fund manager at Catalyst Fund Managers Alternative Investments, and has more than 20 years’ experience in the property sector. The team specialises in listed real estate, with R1 billion under management in local and global hedge fund strategies.
