Justin O’Connor, Cordea Savills: “Turbulent markets create opportunities to identify mispricing of risk”

Justin O’Connor (pictured), chief executive and chief investment officer of property fund manager Cordea Savills, says that new opportunities with the potential to deliver outperformance over the longer term exist in the Nordic region, where secure property market fundamentals have prompted the reopening of the Nordic Retail Fund, and London residential development, where a new fund aims to benefit from the current shortage in capital funding by negotiating favourable terms with developers.

GFM: What is the history and background of your company, principals and funds?
 
JOC: Cordea Savills was formed in December 2003 to separate the longstanding existing Savills Fund Management business from Savills plc and to provide the infrastructure for the development of a larger and stronger business going forward. Combined with Savills Fund Management, Cordea Savills has a track record of 25 years.
 
The firm is a medium-sized investment management house that manages various funds and mandates in the UK and continental Europe, ranging from low-risk core products that are typically focused on a specific country and/or sector to pan-European funds, as well as opportunistic products that can be very specialised. The focus in the recent past has been on core and core-plus products.
 
The senior executives at Cordea Savills are executive chairman John Partridge, myself as chief executive and chief investment officer, chief financial officer Richard James and chief operating officer Bill Hackney.
 
GFM: What is the structure of your funds?
 
JOC: Funds are structured to meet investors’ requirements and can be domiciled in the UK, Jersey, Luxembourg or Italy.
 
GFM: What is your client base?
 
JOC: Our client base comprises institutional investors, charities, family trusts and qualified professional investors throughout Europe.
 
GFM: What impact has the recent global financial crisis and economic downturn had on your business?
 
JOC: In common with other property investment managers, some funds were negatively impacted by the crisis. We focused on risk mitigation in those cases and most have now recovered.
 
From 2008 to 2010 the business consolidated, with attention focused on protecting value for existing investors rather than the creation of new investment vehicles. Our approach increasingly emphasised asset management and financial and debt management skills to reflect the challenges of the new macro and property environment.
 
We ensured a high degree of transparency with our investors, and received high levels of support for the positive actions taken to protect value in our opportunistic funds. Elsewhere, our core and core-plus funds generally held up well during the financial turmoil. We continued to recruit in the investment, financial and administrative reporting areas of the business rather than reducing staff numbers.
 
GFM: What is the investment premise of your funds? What types of property do you invest in, and where?
 
JOC: Our style is that of a value investor. Over the long term, income consistently provides the largest proportion of total return and thus our focus is heavily weighted toward securing and increasing income streams, which in turn preserves and enhances the underlying value in property. In this way we are able to generate higher risk-adjusted returns.
 
Our geographical coverage is the UK and western Europe, concentrating on the major economies plus the Nordic region and the Benelux countries across sectors including retail, residential, office and industrial/logistics.
 
GFM: How do you make investments for the funds?
 
JOC: Thematic research and strategy is used to identify opportunities and risks across and within property markets, which can be in terms of sectors, countries, property types and occupiers.
 
We ensure that we thoroughly understand and appraise the value drivers of property, including security of income, tenancy and lease expiry profile, reversionary rental, potential change of use, and refurbishment and redevelopment angles.
 
We implement initiatives designed to increase rental income, reduce costs and improve the occupier base in terms of mix, credit risk and lease length as well as refurbishing, redeveloping and repositioning of properties through active management to create value.
 
Our investment process also ensures that we operate within a disciplined framework that allows us to invest efficiently and in a timely manner.
 
GFM: What is your approach to managing risk?
 
JOC: Our investment style is low-risk with either an income or total return investment objective. Higher risk investment is only undertaken where we have sufficient in-house expertise.
 
The risks of a specific mandate will be assessed according to the client’s requirements and the nature of the mandate. Once these risks have been identified, an appropriate mitigation strategy is assigned, along with the control mechanism necessary to ensure the risk’s effective management. These risks may include asset concentration, location, tenant covenants and default risk, sector weightings, income return versus capital growth, letting risk and sustainability.
 
GFM: How have your funds performed?
 
JOC: To take a couple of examples, a GBP320m UK pension fund mandate targeting core UK commercial assets returned 11.9 per cent in 2010, compared with a benchmark of 14.5 per cent. However, over the 10 years to the end of December last year, the mandate has averaged an annual return of 9 per cent, compared with a benchmark of 7 per cent.
 
Cordea Savills’ EUR388m European Commercial Fund, a core pan-European fund focusing on western Europe, achieved a 10.4 per cent return last year and averaged an annualised 7.7 per cent between its launch in April 2008 and the end of 2010. The fund has a targeted internal rate of return of 7 per cent and a distribution target of 5 per cent per annum over a 10-year period, which was met in 2009 and 2010.
 
GFM: Are you looking at any particularly attractive opportunities right now?
 
JOC: We are focusing on a number of sectors and regions throughout Europe, seeking investment opportunities that will deliver outperformance over the longer term. Two current opportunities include the reopening of the Nordic Retail Fund due to secure property market fundamentals in the region and the launch of a prime London residential development fund, which will exploit the strong prospects for this sector while benefiting from the current shortage in capital funding by negotiating favourable terms with developers via a variety of financing schemes.
 
Our focus will remain on western Europe in the coming years, but also on other markets where opportunities arise and investors’ objectives can be met. Focus on Asia is growing due to increasing investor interest caused by the relative economic growth prospects of the region, and its extremely favourable demographics.
 
The business focus will also remain on manufacturing high-quality investment products, both pooled funds and segregated mandates. However, Cordea Savills will also respond to developing industry trends such as preferences for club- and investment mandate-type arrangements in other markets. Whatever the vehicle, we remain committed to providing a full-quality service covering portfolio management, asset management and financial management while upholding the highest standards of client servicing.
 
GFM: What developments do you expect to see in the real estate sector in your target market over the year ahead, and in other political and economic areas that may impact it?
 
JOC: The ongoing crisis in the eurozone is bound to impact greatly on our future investment strategies there. Investors are naturally risk-averse in relation to Europe at present, and where possible we continue to focus on secure income streams that benefit from index-linked or fixed uplift lease structures. We believe it is important to prepare for a rate of inflation that may outpace market rental growth in most markets in the short term.
 
We seek opportunities to enhance returns where the gap between yields offered by real estate leases with inflation-linked uplifts significantly exceed those of government bonds with similar characteristics. These are likely to prove of particular interest to pension funds and insurance companies looking for credit-like investments due to the market shortage and pricing of suitable government index-linked bonds.
 
We are also considering the pricing advantages available when accepting shorter leases and/or apparently weaker covenants in prime locations in core countries. Taking a portfolio approach that incorporates staggered lease expiry profiles and/or multiple tenants can offer enhanced value while mitigating the additional risk.
 
Turbulent markets create opportunities to identify mispricing of risk. Any purchasing decisions in this environment will focus on rigorous credit risk analysis with consideration given to indexation and currency hedging. Excess returns will come from careful evaluation and taking controlled risk.
 
GFM: What differentiates you from other managers in your sector?
 
JOC: We believe the combination of the quality of our team and the strength of our processes will provide superior investment performance over the long term. Our services are designed to meet all aspects of client requirements, not just performance. Our product model of a dedicated fund director, portfolio manager and finance manager, supported by asset managers, researchers, administrators and client servicing specialists, provides the client with access points right through our organisation and ensures active and ongoing relationships at whatever levels the client requires.
 
GFM: How do you view the environment for fundraising over the coming 12 months?
 
JOC: Fundraising will continue to be difficult due to economic uncertainty regarding sovereign debt and potential impact on pricing as well legislative changes in Europe. However, we expect fundraising to improve from last year, with investors continuing to appreciate the superior returns available from property, especially in terms of income, compared with other asset classes.
 
GFM: How do you expect your business to be affected by current and proposed regulatory changes?
 
JOC: Cordea Savills is not currently affected by the Dodd-Frank Act, as we do not have any funds that require registration with the SEC, nor do we undertake any general marketing of our funds in the US.
 
However, as unregulated collective investment schemes our funds may be affected by the EU’s Alternative Investment Fund Managers Directive. A small number of our funds may be classified as alternative investment funds and will require the appointment of a depositary or trustee. In addition, under the AIFMD any alternative fund management company belonging to the Cordea Savills Group that is authorised in the EU will need to meet a minimum capital requirement. This will be reviewed nearer the directive’s implementation date in July 2013 to ensure that this condition is met.
 
Cordea Savills Investment Management Limited is a limited licence firm classified as Tier 4 under FSA Remuneration Code rules, which covers recent and proposed EU Directives and have minimal impact.
 
Some Cordea Savills funds could be affected by the EU’s European Market Infrastructure Regulation, specifically on the requirement for a margin to be deposited with a central counterparty depositary on any OTC trades, because physical property assets in which all our funds are invested will not be accepted as collateral.
 
GFM: Do you have any firm plans for further product launches?
 
JOC: As well as the new fund investing in prime London residential property, we are looking to expand our segregated mandate business.


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