Top-performing U.S. fund focuses on unloved real estate
NEW YORK (Reuters) - During a 2009 trip to Hong Kong, mutual fund portfolio manager Michael McGowan came across two 40-story office towers nearing completion in Kowloon East, a formerly industrial neighborhood across the bay from the city center, that were renting space for about HK$10 ($1.30) per square foot per month.
"They were these beautiful buildings, and I thought, ‘Wow, this is so cheap,'" said McGowan, who manages the $135 million Forward International Real Estate fund. The buildings had come to market at double that price, but the rates were cut to draw tenants in the midst of the financial crisis.
McGowan was struck by the award-winning design of the two glass towers, as well as a nearby commuter train station that made them attractive to businesses looking to escape rents of up to HK$150 a square foot per month in Central Hong Kong. After the trip, he bought shares in Wing Tai Properties Ltd, the real estate investment trust that owned the buildings.
That and other similar bets have paid off. The buildings rent for up to HK$35 per square foot now, and Forward International is up 48.2 percent through the end of October, making it the top performer this year among mutual funds tracked by Lipper, a Thomson Reuters company.
The fund's returns are more than 10 percentage points better than those of its closest competitor, the Alpine Cyclical Advantage Property Fund, and it has vastly outperformed the benchmark Standard & Poor's 500 index, which was up 13.1 percent over the same period.
McGowan attributes his performance to a two-pronged strategy: on one hand, he invests in REITs with properties in and around gateway cities such as Hong Kong and London, which have long histories as business centers and cultural capitals and are relatively constrained geographically by rivers, mountains or oceans. He also plays defense by increasing his holdings in less glamorous markets, such as Canada's resource-rich Alberta province.
San Francisco-based McGowan said he adopted this approach in 2009, after his fund fell as much as 51 percent in the wake of the financial crisis, as real estate collapsed. The fund is up nearly 50 percent for the three years since but down 4.27 percent over five years, about the middle of the pack in its category.
FOCUS ON THE GROUND
It has received a boost in 2012 from stimulus measures that have helped commercial real estate markets in Asia and Europe rebound from 2011's lows. Five of the 10 top-performing actively managed mutual funds as of October 31 focus on real estate, according to Lipper, with an average gain of 38.3 percent.
McGowan, a soft-spoken University of California at Berkeley graduate who began his career 25 years ago as a real estate analyst in the Bay Area, credits his outperformance this year to a focus on small- to mid-cap companies that are likely to be overlooked by larger funds.
He makes about six 10-day trips abroad every year. He brings a list of all the REIT-owned properties in his focus city and attempts to see them all.
Earlier this month, he was in Brisbane, Australia, riding a bicycle up and down the city's streets with his laptop in tow. In his backpack, he carried a map of the city, marked with dots and ticker symbols plotting the location of properties - office buildings, malls, hotels and apartments - owned by several REITs. He stopped at each to make notes about location, condition and foot traffic. Overall, he visited 167 properties worth a total of $25 billion.
"You need to get a feel for the neighborhood. If you get a car and driver it's hard to get the guy to stop exactly where you need to," McGowan said. For the same reason, he often rents a local apartment rather than staying in a hotel.
One property McGowan visited, the 1.3 million square foot Westfield Carindale mall, had recently been renovated by Carindale Property Trust, which his fund owns. McGowan said the changes brought more light inside and modernized the facilities, upgrades that he said will attract higher-end tenants.
It's this city-intensive approach that makes McGowan different from managers of many other international real estate funds. Competitor Alpine Cyclical Advantage Property Fund, for instance, places more emphasis on finding undervalued assets regardless of their location, according to fund manager Samuel Lieber's most recent annual report.
Hong Kong-based CSI Properties Inc is Forward International's largest holding, at 10.1 percent of assets. The company focuses on high-end commercial and residential properties in Hong Kong and Shanghai and has returned nearly 53 percent for the year.
The fund's second-largest holding is Canadian REIT Holloway Lodging, which owns 21 hotels in Canada's secondary and tertiary markets. Holloway Lodging owns Days Inn and Super 8 motels that cater to oil and gas drilling crews in resource-rich Alberta. Before making the investment McGowan went to the drilling region around Alberta's Slave Lake and saw no other hotels within a two-hour drive. Holloway's stock is up 6.1 percent for the year and has a dividend yield of 3.1 percent.
Overall, McGowan invests about 50 percent of his portfolio in Asia (including Japan), followed by 30 percent in Canada, 15 percent in Australia and 5 percent in Europe.
THE PATH AHEAD
McGowan's performance comes at a steep cost. With an expense ratio of $1.65 per $100 invested and a sales load of 5.75 percent, Forward International is expensive.
In terms of price, the next closest of the top-performing funds in the category charges $1.35 per $100 invested. What's more, McGowan's habit of frequently buying and selling the same stocks to take advantage of short-term price moves led to 309 percent turnover in the fund's portfolio last year, which can mean higher taxes for investors in a taxable account.
He may find it hard to repeat this year's performance. After the stellar gains of 2012, international REITs are no longer the cheap buys they once were. But McGowan remains bullish on the long-term prospects for his strategy.
"There's a reason that key cities tend to come back. You don't know if it will be six months or three years, but these markets won't ever go away," he said.