Investing in Resilient Urban Trends

on

This article is part of NordSIP Insights – NordSIP Insights – SDGs 2020: 17 Shades Faster. Read or Download the entire publication here.

Tom Walker Co-head of Global Real Estate Securities, Schroders

- Promotion -

When Tom Walker and Hugo Machin joined Schroders as Co-Heads Global Property ­Securities after working together for six years at Australian-based AMP Capital, they knew they wanted to put their stamp on their new fund. “When Hugo and I joined Schroders in 2014, we wanted to create a fund that we would both be passionate about and want to invest in,” Walker says

“Hugo and I started working together in 2006, and we spent the best part of the next decade learning how real estate markets worked. In the process, we developed a philosophy of how an investor should invest to derive the strongest and most consistent returns. When we joined Schroders to take over a global listed real estate strategy, we thought it was our opportunity to make this fund our own, change the strategy, change the process and further improve ­returns for investors,” Walker continues

Urbanisation – A Consistent Driver of Value

The experience of working in the market and observing successes and failures yielded ­essential conclusions for the Schroders duo. “We noticed that the strongest and most ­resilient returns were always created by assets in key cities around the world. Urbanisation is a crucial driver of economic growth and cities dominate a country’s economy.” Walker adds.

“Cities’ networking and efficiencies allow them to become more dominant and increasingly ­attract more people. The conclusion was that urbanisation is a self-fulfilling prophecy and the most defining trend of the 21st century. Once the pieces fell into place, it was clear that the fund had to focus on urbanisation. Having defined our vision for the fund, we needed to find a way to quantify the strength of leading cities to motivate investment decisions.”

Assessing Opportunities – Unbiased Quantification

“In terms of quantifying the strength of leading global cities, our secret weapon is data. We look at several factors, including ­economic growth, proximity to innovation, transport connectivity and the environmental risks. We ­created four proprietary databases with ­millions of data points to help us establish where the most promising opportunities lay.”

The assessment process is not static but rather adaptable, according to Walker. “Our investment process has evolved as our ­understanding of urbanisation grows. At the inception of the fund, in 2014, there were two data sets. The fund started with an economic database mapping which cities have the strongest economies and an innovation database, which ­focuses on ­closeness to innovative univer­sities. In 2018, these two datasets were enhanced with ­information about transportation and ­connectivity. ­Finally, in 2020, the ­environmental database, using data from NASA, the European Space Agency and the Japanese Space Agency added another layer of insight.”

“We use data in a completely unemotional way to quantify which locations are going to be the best for us to allocate capital to,” Walker ­explains. “Using data as opposed to emotion or our gut feeling biases, it is possible to identify the most attractive places to allocate capital. This emotional detachment remains a constant in our approach to how each of the databases and their constituent variables is weighted.”

“One of the key databases which determine how a city ranks is the economic score. Of the relevant economic factors considered, median household disposable income was the one most correlated with rental growth, which is the ­target variable to maximise value for our ­clients. Other salient economic factors inclu­ded GDP, retail sales, and the population growth of ­people aged 15 years and above.

Alignment with SDG 11

“The fund is naturally in line with SDG 11,” Walker says, referring to Sustainable Cities and Communities. “However, although we are aware of the criteria that the UN SDG framework stipulates under SDG 11, the fund uses metrics based on those data determi­nations made in the first stage of the investment ­process.” The emphasis on innovation and transportation is also consistent with SDG 9 – Industry, Inno­vation and Infrastructure, with the focus on the environment contributing to SDG 13 – Climate Action.

“For example, when assessing the environmental risks for a relevant global city, there are three key areas of risk for our investors, and within these there are several sub-factors,” Walker elaborates. “Our first consideration concerns the physical risk of investing in a ­specific city. It’s crucial to determine whether that city is exposed to specific physical risks, such as earthquakes, hurricanes, volcanos, heat stress or tropical storms.”

“Next, the fund considers the wellbeing risk to individuals. Are people going to be ­working in a location where they will be breathing ­polluted air or drinking polluted water? The third ­relevant category is policy risk. What is the government doing to address air quality in any given city? Do they recognise that risk? Are they putting in place policies that will then ­improve that quality of air? These are all im­portant issues to bear in mind” Walker explains.
“Every step of the fund’s investment process before the actual capital allocation to a stock is trying to determine which companies have the most environmentally sustainable assets in the most environmentally sustainable ­location. Economic and environmental strength are inextricably linked. It’s impossible to have an economically strong location that is not environmentally sustainable. Those days are gone. May be ten or fifteen years ago one could have invested in a city that was very economically strong but was not so advanced environmentally. Today that is just not possible.”

The Investment Process

According to Walker, the data-driven quantification of the best investment locations is the starting point of the first stage of the investment process. “Having identified the best cities, it is necessary to select the companies with the best value prospects. That is all done through the data. The funds use several sophisticated python scripts that scrape the websites of companies to generate an up-to-date and accurate geospatial analysis of their portfolios.”

“Our mandate allows us only to invest in publicly listed real estate companies. However, within that mandate, the fund is not constrained.  We invest in a wide range of assets, including residential, commercial, offices, warehouses, infrastructure, hospitals, data centres and self-storage.”

“Having identified the companies with the highest exposure to the leading cities, the second phase of the investment process is very much the normal analysis associated with real estate analysis. We physically visit the properties, assess the demand and the supply of that market, consider the strength of prospective investee balance sheets, analyse the quality of the asset and meet management teams.”

“Where the fund stands out is in the fact that the four databases used in the first stage purely determine which companies are analysed. We don’t waste any time looking at companies that do not have assets in attractive cities.”

ESG Integration for Company Selection

In the second stage of their investment process, after selecting preferred locations and once they begin considering potential companies, Walker and Machin’s analysis integrates considerations about the environmental, social and governance performance of those specific real estate companies.

“ESG sustainability is a crucial part of the fund. Fundamentally, we are looking to invest in the most environmentally sustainable city and to own the assets that contribute the most to a sustainable environment. To that end, the fund is interested in companies that use recycled materials in their construction, falling energy intensity and increased reliance on renewable energy sources, water recycling, etc. In new buildings, tenants only sign a lease on a property if it has strong environmental credentials. Companies and society today need to reduce their environmental impact. Those that ignore this fact will not succeed,” Walker explains

“In addition to environmental sustainability, the fund also considers the social credential of these companies. Considerations about real estate companies’ contribution to their local areas and their communities and whether they are providing jobs are important for investment decisions. The fund prioritises companies that are doing this very well. Hopefully, that creates a self-fulfilling prophecy. If the companies have a lower cost of capital, they can work towards further improving their portfolio and their sustainability ratings,” adds Machin.

The Global Real Estate Sustainability Benchmark’s (GRESB) analysis shows that the fund owns some of the world’s leading sustainable real estate companies, as well as the key players in their subsectors, including self-storage, commercial or industrial real estate. In Sweden, the fund owns shares in Faberge, which has extremely promising environmental credentials, a real estate portfolio solely focussed on Stockholm and are listed on the stock exchange.

Value Creation in the Post COVID-19 World

“We are always looking to evolve in terms of our investment assessment.  Although there are no plans to add new databases to the Schroders Global Cities fund, the existing sources are updated to improve our information and find better opportunities,” Walker says.
“The fund has performed well over the last 5 years. Investing in resilient Global Cities allows the fund to do well in rising markets and in difficult times,” he explains. “So far this year the fund has outperformed our benchmark by 8%, following a 10% outperformance last year.” Please note that past performance is not a guide to future performance and investors may not get back the original amount invested.

Looking ahead at investment trends in a post-Coronavirus world, the future remains uncertain, of course, but Walker discerns some favourable patterns. “The portfolio is positioned to profit from trends which will be accelerating in the next decade, because of COVID19. Lockdowns have favoured online retail and working from home, to the detriment of traditional retail and offices. There will be fewer interactions in offices, but the remaining interactions will be more important and still take place in a city. Suburban office locations will be particularly fragile. Warehouses and data centres will benefit.”

“The cities of 2050 will be far more environmentally sustainable. Comparative advantage and the pressures of agglomeration will also lead to increased specialisation. There will be an even stronger tendency towards a select few cities becoming the dominant knowledge hubs for specific industries, and will be the drivers of economic growth for the countries they are in,” Walker concludes.

 

Photo by Sean Pavone © Shutterstock

Partner message

COVID-19 has led to a new appreciation of the importance of healthcare in ensuring all members of society thrive. So where should investors be looking to find resilience in an industry facing enormous change?

Continue to read

NordSIP Insights

Most read this week

BlackRock and Vanguard’s Climate Credibility Under Fire?

Stockholm (NordSIP) - In a new report from Majority Action, a non-profit, non-partisan organisation focusing on holding corporations accountable for their investments, BlackRock and...