Pure fiction to say property trusts are a ‘low-risk’ option.

Posted On Monday, 23 May 2005 02:00 Published by
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Property punted as an alternative to boost returns

Business Times

22 May 2005

I RECENTLY read an article in a national daily under the heading: "Property unit trusts provide low-risk alternative to the money market."

The article formed part of a special feature on investments.

The headline immediately caught my eye because the classification of property as a low-risk investment was certainly unusual in my opinion.

In essence, the author was suggesting that with money market returns having fallen in the low interest rate environment we are now experiencing, investors should look for an alternative to boost returns.

This view was expressed as follows: "Though some money market funds outperform their peers by taking on slightly greater risk to give their funds a bit of a boost, it is property unit trusts (Puts) which provide a genuine low-risk alternative to the money market."

I read the paragraph a few times to make sure I had not misunderstood its meaning

The author was saying that instead of putting my money in the money market that consists of short-term deposits and short-term negotiable instruments, I could invest in a property unit trust and have a genuine low-risk alternative to the money market.

Investment risk can be defined in many different ways. Personally I believe the greatest risk investors run is that they will not earn a real rate of return on their investments.

In other words, their investment return will not beat the rate of inflation. The consequence of that is the erosion of purchasing power.

However, one of the more common measures of

investment risk is to look at the variance in return from an investment over periods of time.

This is expressed as a percentage and the most common period used for this purpose is one year. The result is a measure known as annual volatility.

If an investment has an annual volatility of 5% it means that the investment return could be as high as 5% above or 5% below the historical average annual return of that investment over a one-year period.

Armed with this information I wanted to test the claim that Puts offered a low-risk alternative to the money market.

Historically the money market has an annual volatility of 2% to 3%. Listed property on the other hand has an annual volatility of 14% to 16%.

Quite a difference, don’t you think?

If you look at equity, the asset class that people regard as very risky, you will find that its annual volatility is 18% to 20%. So if you are looking to group different asset classes together based on annual volatility, listed property and equities make good bedfellows.

The money market is in a different league altogether and, viewed from this perspective, the author’s comments are nothing short of reckless.

Many investors make the mistake of looking at investment yield instead of total return when considering an investment.

In the case of Puts, while the yield may be attractive, investors need to know that there is significant volatility in the total return because of the fluctuation in the underlying capital value.

As an investor in Puts you need to accept that you are exposing yourself to volatility not too dissimilar to the equity market and certainly nothing like the money market.

Investors should also not be fooled by the tremendous returns listed property has delivered over the past seven years.

Since 1998 the prime rate of interest has more than halved. This has provided a tremendous boost to the property and bond markets. Both have performed significantly above their long-term average.

But for this performance to be maintained, it will be necessary for interest rates to continue their dramatic decline.

Can you see the prime rate dropping by more than half again in the next 10 years? Think about it!

Scott is CEO of The Wealth Corporation

Publisher: Business Times
Source: Business Times

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