Kirschner says he and his co-managers are most focused on sectors that can sustain their growth and maintain sustainable pricing power in a variety of economic environments. “What drives that pricing power is positive supply demand, so we look for sectors where the leverage is in the favor of the landlord,” he explains. “We’re also focused on businesses that can defend well when things are going the other way, and we seek out companies that have a valuation we think is reasonably attractive relative to the rest of the market.”
Kirschner says that in the second quarter he and his partners started to rotate the portfolio to take advantage of some of the disconnect they saw in the broader market. That led them to buy companies in sectors such as cell towers, single-family homes for rent, and industrials. Recent holdings in those sectors included the likes of American Tower Corp., a cell tower REIT; Invitation Homes Inc., a home-leasing company; and Prologis Inc., an industrial REIT whose forte is warehouses.
They also sold some holdings that were performing well relative to the market but suffered from stretched valuations. These included companies in some areas of healthcare as well as the net lease sector comprising single-tenant, freestanding commercial properties.
Capturing The Angles
Kirschner says the fund’s managers combine both top-down and bottom-up approaches to portfolio construction. From the top-down perspective, the managers tap into members of Cohen & Steers’ sizable research team who focus on risk and macroeconomic considerations.
“We acknowledge that understanding the macroeconomic environment is very important,” he says. “But in terms of getting a real edge, we don’t feel we have a sustainable competitive advantage from the top down. So the top down is maybe 20% of what we do, and the bottom-up underwriting of the stocks and sectors is about 80%.”
Kirschner describes the fund’s investment process as very disciplined and ever-evolving. The portfolio managers work with an analyst team that each has its own coverage universe. They hold both informal meetings and more formal investment committee meetings where portfolio managers, analysts and associates debate different issues ranging from stocks to sectors to the macroeconomic environment.
“We look at what the inputs are that are driving our numbers, and try to challenge each other’s assumptions and viewpoints, and we try to challenge our thesis and what could be wrong with our thesis,” Kirschner says. “We try to capture each and every angle that exists. That whole process drives not just our views on value but helps bring to the surface what are the best ideas.”
He notes the portfolio managers try to come to a consensus as much as possible in terms of which stocks to own and how much they should own, and what that means in terms of the fund’s sector weights and risk profile. “It’s a team-based approach from the research analysts and associates up to the portfolio managers,” he says.
Upside, Downside
The fund’s comprehensive approach to portfolio construction has created a product with a higher Sharpe ratio (higher is better) and a lower standard deviation (lower is better) than both its category and index over the past three-, five- and 10-year periods, according to Morningstar. Its upside capture ratio has been in line with both the category and index during these time frames, while its downside capture ratio has consistently been less, to the tune of 10 percentage points.
In discussing whether this fund is more about upside capture or downside downside, Kirschner says he and his partners try to keep it balanced over the long term but it probably is a tad better at downside protection. That’s because the team tends to favor companies that he describes as good operators with properties that can outgrow the market and have strong balance sheets, and which are purchased at a reasonable price.
“Those things tend to defend better when the market is going down, but if the market is in a risk-on environment, the rising tide lifts all boats,” he says.
As of early September, the market was firmly in risk-off mode. This turbulent investing environment has caused a lot of financial pain, but long-term investors in real estate would be wise to stay the course, and investors thinking of adding real estate to their portfolio could use the current downdraft to stake out positions.
At least that’s Kirschner’s take. “The diversification benefits of real estate are well-documented,” he says. “Total returns of real estate over time have been very competitive. After we get through that slower growth environment and consumers can regain their health and inflation gets under control, then we feel that real estate can take off in terms of responding to the healthier demand environment and a more reasonable inflation and interest rate environment.”