How do you manage concentration risk and uncover opportunities?

Stuart acknowledges the concentration risk in the local listed property market, particularly in index-heavy names like Goodman Group, which dominates traditional benchmarks. However, Phoenix Portfolios takes a benchmark-unaware approach, expanding its investment universe to include a much broader set of opportunities.

“To assist us in creating the best risk/return trade-off, we have expanded the universe of potential holdings to be around three times the size of the benchmark portfolio,” Stuart explains.

This allows Phoenix Portfolios to uncover hidden opportunities, particularly in smaller property stocks that are often overlooked by large institutional investors. The research process involves fundamental analysis, meeting management teams, and conducting site visits to assess long-term value.

Another key differentiator for Phoenix Portfolios is its focus on after-tax returns, which is particularly relevant for Australian investors.

“We fully value the franking component of any dividend or distribution because we know our investors will,” Stuart notes. This approach enhances after-tax outcomes, making listed property even more attractive for Australian investors.

The Cromwell Phoenix Property Securities Fund is a highly-rated, award-winning fund that follows a benchmark-unaware strategy, removing the concentration risk of investing in the index. It focuses on total return outcomes for investors, aiming to outperform the S&P/ASX 300 A-REIT Accumulation Index over the long term while maximising franking credits where possible.

Our approach seeks to uncover opportunities that maximise after-tax returns while delivering lower total risk compared to both the benchmark and global listed property investments.

The importance of franking credits

The Cromwell Phoenix Property Securities Fund is managed to maximise after-tax returns—the real measure that matters to investors. However, the funds management industry typically reports returns on a pre-tax basis, often under-pricing the value of franking credits.

Over the 3-, 5-, and 10-year periods to 30 June 2024, the Fund delivered an average uplift from franking credits of 0.84%, 0.71%, and 0.52%, respectively—effectively topping up investors’ income.

Tax-deferred distributions occur when a fund’s cash distributable income is higher than its net taxable income. This difference arises due to the trust’s ability to claim tax deductions for certain items – such as tax decline in value on plant and equipment; capital allowances on the building structure; interest and costs during construction or refurbishment periods; and the tax amortisation of the costs of raising equity.

In tax technical terms, tax-deferred amounts can give rise to distributions from property trusts of “other non-attributable amounts” for trusts that have elected to be Attribution Managed Investment Trusts (AMITs) and “tax deferred” components in non-AMITs – all referred to as tax-deferred distributions in this article.

Tax-deferred distributions are generally non-taxable when received by investors. Instead, these amounts are applied as a reduction to the tax cost base of the investor’s investment in the property fund, which is relevant when calculating any Capital Gains Tax (CGT) liability upon disposal of the investment units or once the tax cost base has been reduced to nil. Therefore, any tax liability in relation to these amounts is ‘deferred’, typically until the sale or redemption of an investor’s units in the fund when CGT may arise.

At its simplest, tax deferral works as follows: suppose a trust earns rental income of $100 and has building allowance deductions of $20. Then the net taxable income is $80, which is distributed to unitholders to be included in their taxable income. The remaining $20 of cash is distributed to the unitholders too, but for tax purposes it is regarded as a reduction in cost base of the units invested in the fund by the unitholder.

So long as the accumulated tax-deferred income is less than the investor’s acquisition cost, the tax is generally able to be deferred. If tax-deferred amounts have reduced the cost base to zero – that is, if the investor has received total tax-deferred distributions at least equal to the original cost of the investment – then any excess must be declared as a capital gain in the year it is received.

Capital gains are distributed by a trust only when the trust sells capital assets at a tax profit. These gains are then subject to tax in the investor’s hands, the same as other gains. Alternatively, investors are taxed on any capital gains, including any accumulated tax-deferred distributions, when they dispose of their units in a trust or the trust is wound up.