Guru Speak

The balancing act of creating a return that is low risk and which consistently and significantly out¬performs cash deposits is one of a multitude that fund managers have wrestled with since before the phrase "prices can go down as well as up".

All too often the concept 'high risk, high return' coupled with the 'low risk, low return' phrase is packaged with investment vehi¬cles that don't offer much in between. Today I'm going to focus on two investment vehicles that use 'out of the ordinary' funds that not only offer minimum risk but consistently attractive returns, whilst also allowing you to diversify your investment port¬folio away from the sometimes volatile equitybased products.

The first of these invests in a concept called a ground rent fund. What are ground rents? The origins of ground rents date back to the feudal system in England more than 400 years ago as a means for landowners to release capital by leasing ground. Under the terms of the lease on a prop¬erty, leaseholders must pay a rent to the owner of the land (the free¬holder). These rents provide income for the fund. The invest¬ment strategy focuses on owner¬ship of freehold residential prop¬erties in the UK which have rever¬sionary value and secure running income.

Reversionary value can be described as the increasing capi¬tal value of a property to the free¬holder (the fund) as a result of the approaching date when the occupier (the leaseholder) loses the right to live there. Thus a property becomes more valuable to the fund as the lease expiry date approaches. At the lease expiry date the full freehold value of the property accrues to the fund as a capital gain.

At launch in early 1996, residential groundrent portfo¬lios of very long leas¬es could be pur¬chased giving a secure running income return of well over 10 per cent per annum. Subsequently, investor demand for this class of asset greatly increased. The one, three and fiveyear perform¬ance, as at July 31, was 9.85 per cent, 32.6 per cent and 56.77 per cent, respectively.

An example of how this type of fund operates is as follows: a prestigious central London port¬folio owned by one of the UK's major ancestral landlords became available in late 1999, which fitted well within the fund's investment objectives and strate¬gy and had the characteristics to exploit the opportuni¬ties created by the revised landlord and tenant legislation. The fund was suc¬cessful in its bid for this very desirable portfolio.

The portfolio included several important large blocks of flats occu¬pied mainly by ten¬ants with short leas¬es.

The acquisition moved the emphasis of performance away from pure income returns towards capi¬tal appreciation as a result of the reversionary nature of the portfo¬lio. This gave an additional advan¬tage, as the fund is not subject to UK capital gains tax, but does pay income tax on net rental income. This provides the offshore investor access to the UK proper¬ty market wrapped in an offshore umbrella providing the investor with taxfree capital gains.

The second type of investment vehicle that I'll be dealing with today focuses on the growing stu¬dent accommodation market. This type of fund has been designed as a vehicle for investors wishing to participate in a low volatility investment return¬ing 'better than cash on deposit', whilst also making a real contri¬bution to the UK educational sec¬tor.

Launched as an openended collective investment scheme in June 2000, the fund seeks to achieve a combination of capital growth and relative security for investors by concentrating its assets in UK property portfolios and other investments in proper¬tyrelated funds and/or compa¬nies. The primary target for acquisition by the fund will be freehold or longterm leasehold properties comprised of student accommodation supporting the various colleges and universities in the UK. Such acquisitions may be leased either to institutes of education, including colleges and universities, or directly to individ¬ual students for the purpose of student accommodation and other noneducational facilities. This ensures a steady and grow¬ing demand for primequality stu¬dent accommodation in the years to come.

The fund invests in affordable, hitech security, ensuite apart¬ments which are of sufficient quality to allow universities to use them as conference accommoda¬tion outside of term. The one, three and fiveyear performance in this instance as at 31/07/08 was 10.05 per cent, 32.48 per cent and 56.39 per cent, respec¬tively.

The broadbase appeal of these investment vehicles may be an answer to the fund managers' perennial problem of how to pro¬vide a lowrisk strategy with con¬sistently attractive returns.