Expert Names 2 ASX Stocks That Exploit Our Cravings

Ask a fund manager

The Motley Fool talks to fund managers so you can get a taste of how the pros think. In this edition, Atlas Funds Management Chief Investment Officer Hugh Dive explains why ASX shares, his two top holdings, are so fantastic.

Investment style

The Motley Fool: How would you describe your fund to a potential client?

Hugh Dive: I’m Hugh Dive from Atlas Funds Management, here to tell you about the Atlas High Income Property Fund. This is an income-linked real estate fund. We own a bunch of real assets and run a covered call option strategy on the assets we own. This allows us to collect dividends.

We have chosen real assets, namely listed infrastructure and listed real estate, as their distributions are not particularly volatile, and therefore much easier to place calls. Unlike, for example, banks or miners, where distributions can be very volatile. [Real estate ASX shares] don’t move that much. It’s a good thing for us.

Secondly, we sell a covered call strategy on this, which allows us to harvest additional income for our investors. Systematically, we would see investors overestimating blue skies, and that results in nearly 80% of our calls that we sell expiring worthless, and that’s a good source of income for our investors. This allows us to pay investors 7%, or 1.75%, each quarter.

The fund has been in existence since early 2017. It is listed on the ASX under the symbol AFM01.

It’s a growing strategy that’s doing pretty well right now, as real assets are seen as very popular and the covered call strategy is working well.

The biggest convictions

FM: What are your two biggest participations?

HIGH DEFINITION: The two biggest holdings are Shopping Cntrs Austrls Prprty Gp Re Ltd (ASX: SCP) and #1 Arena REIT (ASX:ARF).

SCA Property Group is a group that owns 91 shopping centres, and it’s not the glitzy Westfield malls you see in the center of town, but generally a Woolworths Group Ltd. (ASX: WOW) or Coles Group Ltd. (ASX: COL) with a Dan Murphy’s or a BWS next door. So sort of a consumer staples retail.

[It had] very well done during [COVID-19]. People still had to eat. People always like to drink alcohol.

The 91 malls are worth around $4.4 billion, and what we love is that they have really long lease terms. The average lease term is almost 10 years, and everything is linked to inflation. So that would benefit from additional inflation, particularly food inflation, to the extent that mall landlords, like SCA, have a base rent plus a turnover rent component, so that ‘they get a little more when more money comes through. So, food inflation is a very good thing for this company.

The second largest holding we have in the portfolio is a company called Arena REIT. It is a company that owns 256 childcare and healthcare centers across Australia. Again, a very long lease. We like long leases. The term of the lease is even longer there, at 20 years, all linked to inflation.

We saw in March 2020, Arena REIT fall very heavily, thinking that people would not go to nurseries. Then the government intervened. Despite the fact that it was down almost 40% in March, [there was] absolutely no change to their income. Everything followed along. Everything is linked to inflation.

One of the great things about Arena REIT is that their lease structure is quite different from most real estate trusts in that they are secured by a triple lease. This means that the person renting the center must pay maintenance fees, ongoing taxes and improvement fees. So that means there’s a very clean pass-through, whereas the likes of Dexus Real Estate Group (ASX:DXS) or Scentre Group (ASX:SCG) actually have to pay to upgrade their assets.

So very stable, very high visibility on the results, and very long-lasting results. These are two companies that are our two largest holdings, and we’re very, very happy with how they’ve turned out.

FM: Is the fact that Arena’s deal with its tenants is a little different, is that a consequence of the babysitting industry, right?

HIGH DEFINITION: Correct. There are often quirks in the different sectors. For example, one of the quirks in office real estate trusts is that tenants get incentives, and that incentive goes from 10% [to] 30% of the lease, and it’s usually structured in terms of amenities or even just cashback. So you’re paying an all-inclusive rate of $1,000 per square yard, but you may really only be paying $700.

FM: I see the Arena stock price has done very well. Is it now well above its pre-COVID high?

HIGH DEFINITION: Yeah. It was a pretty crazy time during COVID for a lot of these real estate trusts, where the market saw anything related to real estate or property as suddenly worthless and everything was going to go down.

But what has been shown over the past two years is that this is not true.

There was an opinion that toll roads were going to be stranded assets. No one will ever use a toll road. Of course, no one goes to an office anymore. Malls were going to be cavernous, empty houses filled with pigeons, and day care centers and medical centers were going to be unused.

And everything turned out to be wrong.

One of the benefits of experience and having done this for a long time is that these extreme situations rarely occur, and you have to attach a low probability to fundamental changes in human behavior.

When I look at the real estate disasters, in 480 BC the Persian King Xerxes ransacked the agora in Athens, and it impacted Athenian retail sales as buyers were put to the sword and the city was burnt down. But just 10 years later, everything was rebuilt and Athenian retail sales continued to rise. And indeed, I was actually in this mall that was thousands of years old about a year or two ago and bought some stuff there.

Human beings will bounce back. It didn’t turn out that human beings permanently sit in their caves and never come out because it’s just against human nature. We like to dine at restaurants. We like to buy things. And in offices, we like to get together to increase productivity.

FM: Even the caves are real assets, so someone has to rent them.

HIGH DEFINITION: Ha ha ha, yeah.

About Donnie R. Losey

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