Mutual Funds

Kotak International REIT FOF NFO: Wait and watch

Hari Viswanath BL Research Bureau | Updated on December 18, 2020 Published on December 18, 2020

The REIT fund-of-fund is the first one in India to invest in international REITs

Kotak Mutual Fund has launched India’s first global REIT Fund of Fund (FOF). The open-ended scheme is open for subscription till December 21 and will also be available at the daily NAV thereafter.

Real Estate Investment Trusts (REITs) are companies that own, operate or finance income-generating real estate. Investors who buy shares or units in REITs get a share of the real-estate assets that the REIT invests in. REITs enable even small investors to participate in realty investment.

Across countries, REITs benefit from favourable tax regimes if they distribute most of their annual earnings as dividends (at least 90 per cent in many countries). Hence, REITs can be an an investment option for investors seeking regular income (yields).

Besides yields, investors will also gain or lose from capital appreciation or decline in the value of the shares/units of the REIT. This will depend on how the underlying business of REIT fares, changes in treasury yields, and investor perception of the same.

The REIT sector in India is still nascent with scarcity in listed investment opportunities (Embassy Office Parks REIT and Mindspace Business Parks REIT are the two listed ones). The Kotak FOF is an addition to this space, and a novel one at that.

Novel offering

The FOF will invest in SMAM Asia REIT Sub Trust (Sumitomo Mitsui DS Asset Management Company) which is a REIT fund that invests in Asia-Pacific REITs. Currently, around 80 per cent of the fund’s exposure is to REITs in Singapore and Australia, with the rest in New Zealand, Hong Kong, Thailand, Malaysia and India (1 per cent). The current AUM of the fund is $1.2 billion.

The fund’s investment strategy is based on a bottom-up approach with a focus on profit growth, dividend yield, valuation and market liquidity. Its investments are in REITs across segments such as residential real estate, warehouses, office space, logistics and data centres.

Thus, the Kotak FOF offers international, asset and currency diversification to investors. This is unlike the existing Indian REITs where the exposure is mainly to the Indian office space.

Factors to consider

Investors should keep in mind the following factors about the Kotak FOF.

One, capital appreciation in REITs comes from two factors — increase in revenue/profits and market value of the underlying asset (driven by a robust economy or business), and from decline in treasury rates that make REIT yields attractive for investors.

With interest rates at zero or near-zero levels across most countries the SMAM fund investing in, capital appreciation benefit from decline in treasury rates seems unlikely. Hence, capital appreciation will likely have to come only from a robust economy driving higher income (such as rents) and value in underlying assets of the REITs.

On the other hand, increase in interest rates without a proportionate increase in income could adversely impact REIT prices. This could hurt more, given that REITs are generally leveraged entities that have to service debt at prevailing interest rates.

Two, the way Covid-19 might structurally change people’s behaviour patterns is also uncertain. Trends such as work-from-home, digitization and e-commerce will have a negative impact on some segments like office spaces, shopping malls, and a positive impact on segments such as data centres.

The long-term impact of these, even assuming a robust economy, is still not clear, but will likely be structural for some segments. At the same time, a good asset manager may be able to capitalise on opportunities created from this uncertainty.

Returns

Three, while the FOF investor presentation mentions that the SMAM fund’s CAGR of total returns over a nine-year period till 2020 is around 15 per cent, if it is adjusted for additional expense ratio due to the FOF structure, the returns will be around 14 per cent. This is not much different from Nifty annual returns over the same period — around 14 per cent. Besides, past returns are not indicative of future returns.

Four, the correlation between annual returns of the fund and the Nifty 50 (2012 to 2020) is moderate at around 0.65. The correlation between REITs and international equities in the previous decade (2010-2019) was 0.58. Based on this data, we can infer that the correlation between equities and REITs is moderate and, thereby, the diversification benefits are also moderate.

Five, the trailing dividend yield of the top 10 holdings of the fund (approximately 60 per cent of total portfolio) is 4.3 per cent. The trailing dividend yield of Embassy Office Parks REIT is 6.7 per cent. Mindspace Business Parks was listed only in August of this year. Its dividend for FY22 is expected to be around 6 per cent of its current trading price. So, the dividend yields of Indian REITs appear better than that of the fund.

Six, FOFs are treated as non-equity funds for the purpose of taxation. So, long-term capital gains will be taxed at 20 per cent after indexation, and short-term capital gains will be taxed at the investor’s slab rates.

Seven, the minimum investment amount in the FOF is ₹5,000 and in multiples of ₹1,000 after that. This is lower than the minimum investment amount of ₹50,000 in REITs in India as mandated by SEBI.

Given the above factors and broader market optimism across global markets, investors could wait for more clarity on the economic cycle and on the structural changes happening across different segments in the REIT sector.

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Published on December 18, 2020
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