State intervention calls for
risk circumvention

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State intervention in the form of a planned cap on rents across Germany’s capital city, Berlin, has led the Global Real Return team at Newton to reassess its investments in real estate.

During the second quarter, the team reduced exposure to German property company Deutsche Wohnen SE, from 1.59% at the end of the first quarter to 0.97%, and LEG Immobilien from 1.32% to 0.96% in the alternatives sleeve (13.37%) of the BNY Mellon Global Real Return Fund.

“Following the city of Berlin’s proposals to cap residential rents, we reduced the size of the positions in real-estate companies Deutsche Wohnen and LEG,” the Newton Global Real Return team said in its most recent quarterly commentary. “While we believe many of their fundamental attractions remain intact, we felt the portfolio’s exposure was too high in the context of greater ‘state intervention’.”

‘State intervention’, one of the nine core themes, which Newton uses to inform its investments, is based on the idea that authorities have engaged in a greater level of intervention and regulation post global financial crisis in an attempt to propel economic growth. Broadly, the team believes this increases the potential for misallocation of capital and may cause volatility in markets, as well as inflated asset prices. When the team notices instances of ‘state intervention’, it looks to assess the impact on individual securities rather than make sweeping judgements based on broad sectors or regions.

The team’s decision came in June, after the Berlin’s local government announced a bill that would place a limit on how high residential rent can move. While the limit has yet to be disclosed, certain other details about the plan have been revealed. It is set to go into effect in June 2020 and a typical fine for those who do not adhere to the rules could be as high as €500,000 ($560,775).

One of the reasons local authorities are implementing the cap is because housing costs have doubled in the city over the past decade.1 Some of this surge has been driven by the city’s population increase by almost 400,000 since 2009.2

The chart below shows how, from 2011 to 2017, Berlin has experienced the most extreme rise in rent prices compared with other major cities in Germany.

Portfolio activity

Elsewhere, the Global Real Return team added new holdings in Additional Tier 1 (AT1)/ contingent-convertible bonds in the second quarter, issued by what it believes are some of the largest and most robustly capitalized continental European banks.

The team believes AT1s, which were put in place following the financial crisis to improve the European Union banking sector’s ability to withstand future economic shock, offer an attractive risk-adjusted return profile in context of the capital strength these banks exhibit today as well as ongoing policy support by the European Central Bank.

The team also reduced portfolio duration, or sensitivity to interest rate risk, over the period by about a year as it took some profits on 10-year and long-dated U.S. Treasuries and German Bunds following a sharp decline in yields.

“The latest drop in yields has taken the global stock of negative-yielding sovereign debt to over $13 trillion. Notably, during the quarter, the benchmark US 10-Year Treasury Yield dropped below 2% for the first time since Donald Trump’s election victory in November 2016,” the team said. “That being said, despite the generally lower yields on offer, we still view government bonds, and especially longer-dated US Treasuries, as being capable of producing valuable returns for the portfolio in a number of credible scenarios, and thus maintain some exposure.”

Team’s outlook

With a slowdown in global growth starting to surface against the backdrop of global trade concerns, expectations of monetary intervention have increased. The team believes this could signal that positive returns from risk assets experienced in the first half of the year may not hold momentum in the second half.

“We still see good potential from the portfolio’s income-generating investments, in areas such as alternatives and emerging-market debt, as well as favored equities,” the team says. “However, if we are indeed nearing the culmination of the economic cycle, we believe the portfolio’s direct hedges should prove their worth, US Treasuries may also deliver further upside, and finally, we believe gold is likely be a beneficiary of the potential policy response.”

1 Reuters: UPDATE 2-Berlin’s ballooning rents to be frozen for five years, 18 June 2019

2 Needle Berlin: What’s Changes in Berlin in a Decade? Ten years of ‘Moving to Berlin’, 13 March 2019


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