The big property conundrum
The UK financial regulator is looking at potential changes to commercial property funds to avoid a repeat of last year’s investor panic with the sector. It is part of a wider probe into the use of illiquid assets in open-ended funds.
Several property funds suspended trading in July 2016 as investors scrambled to get their cash out. There was widespread concern that the Brexit vote would hurt the property market.
The funds suspended trading as they wanted to avoid asset fire sales in order to generate cash to meet redemption orders
Investment funds are essentially the only way for the general public to gain exposure to commercial property, whether that’s shopping malls, offices, leisure destinations or warehouses.
Therefore the Financial Conduct Authority’s (FCA) consultation is very important for anyone with exposure to commercial property.
CASH RESERVES AREN’T ENOUGH
A large number of funds hold substantial cash buffers to protect against a rush of ‘sell’ orders from investors. Sadly that is only a partial solution.
Standard Life UK Real Estate (GB00BJFL1639) had reserves representing 13% of the fund’s value but it was one of the first to suspend trading. Other funds hiked their exit fees to discourage investors from pulling out.
The fundamental problem is clear. Investors want to be able to buy and sell funds whenever they want. The underlying asset class held by these funds doesn’t work in the same way as a fund that holds individual stocks and shares and which can easily pay investors back their money on demand as it has more liquid assets.
If you put your house on the market you would not expect it to be sold within minutes. Even if a sale is agreed, concluding the transaction would likely take at least a month.
A fund manager trying to sell its interest in a commercial property would also struggle to achieve a sale in a short time-frame.
Investors therefore need to take a more realistic view regarding the speed at which property funds can sell assets.
WHAT IS THE BEST SOLUTION?
Solving this problem is likely to require a compromise between the interests of asset managers and investors as well as between those who look to sell and those who stay invested.
Ryan Hughes, head of fund selection at AJ Bell, comments: ‘There is not a perfect solution if you want to retain daily liquidity in these funds.
‘The only solution which really works is to accept that certain types of funds shouldn’t be daily traded and instead allow bi-weekly or monthly trading. The problem is, there’s absolutely no advantage of any fund manager being first to implement this.’
DON’T PANIC IF IT HAPPENS AGAIN
In the meantime it makes sense to wait and not panic if a trading in fund is suspended. That essentially gives the manager the chance to sell assets so it can eventually resume trading.
‘In reality, people may not need to wait very long for this to happen,’ says Sally Merritt, head of product for Saga Investment Services. ‘Regardless of timescales, a trading suspension ultimately just helps to ensure that those who cash out early don’t leave remaining investors to bear the burden of further price falls in the market.’
Hughes notes M&G Property Portfolio (GB00B8FYD926) sold £700m worth of assets while trading was suspended at a 3% discount to their pre-Brexit price. ‘If they hadn’t suspended trading they would have been selling at a much more significant discount; it would have been a fire sale,’ he adds.
FUND MANAGERS DID THE RIGHT THING
AJ Bell’s Hughes believes managers acted ‘responsibly’ last year with many introducing suspensions even though they still had at least 10% liquidity because they could see the ‘direction of travel’.
He believes the problem was created because a lot of ‘hot money’ had flowed into commercial property as valuations recovered from the lows hit during the financial crisis.
The vote for Brexit acted as a catalyst for a lot of that ‘hot money’ to come out.
Ultimately it is up to individual investors to understand what they are investing in and knowing who they are invested alongside.
A property-focused investment trust is perhaps a better option if you want daily liquidity.
That said, if you try to sell when the market is in panic mode then you will probably do so at a significant discount to net asset value.
We believe it is better to accept commercial property as a long-term holding where the majority of the return will be delivered through income rather than capital gain.
HERE’S WHAT THE REGULATOR IS PROPOSING:
• A cap on the illiquid assets held within a fund (or in other words a minimum buffer of liquid assets).
DOWNSIDE? This could negatively impact returns if fund managers are forced to hold more cash.
• Split the investments of institutional and retail investors, with
different terms applicable to each.
DOWNSIDE? One class of investor is likely to enjoy an advantageous position.
• Diversify the investor base of these funds.
DOWNSIDE? Unclear how this would be achieved.
• Reduce the frequency of dealing in these funds.
DOWNSIDE? Would further undermine the appeal of these funds relative to other ways of gaining exposure to property.
• Develop a secondary market in units of open-ended funds.
DOWNSIDE? This would represent a fundamental shift in the mutual fund industry and would be very complex to implement.
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