Why property fund gating is prudent

Running up close against their liquidity buffers – the pool of more liquid investments they keep in order to fund redemptions in normal markets – they have concluded that gating is necessary to avoid being forced sellers of illiquid property assets to fund the extraordinary levels of redemption seen since the UK voted to leave the EU.

This is, it must be emphasised, a prudent response in the circumstances.

The alternative, a fire sale of property assets, would be bad for all investors - a fact which the managers will have taken into account in deciding to gate.

The alternative, a fire sale of property assets, would be bad for all investors - a fact which the managers will have taken into account in deciding to gate. Cathy Pitt

In the closed-ended world, Reits and property investment companies (PICs) have derated significantly since the Brexit vote and investors wanting to trade out of those companies will have to do so at a significant discount to net asset value.

The difference, of course, is that the fund managers remain free to take long-term decisions about the portfolio without having to worry about funding investor redemptions.

Why the extraordinary levels of redemption requests? Some investors will have been spooked by the generally negative effect the Brexit vote has had on sentiment as regards the UK commercial property market and will be allocating away from real estate.

Others may be making sure they get to the front of the redemption queue, perhaps having been caught out at the time of the 2008 financial crisis, which was the last time we saw significant suspensions of open-ended funds (particularly hedge funds).

Still other investors with mandates that require allocation to real estate may be redeeming units in open-ended funds at or around NAV in order to switch into Reits and PICs while they are heavily discounted and look like good value.

These gatings highlight the issues with holding illiquid assets in open-ended funds.

At the time of the global financial crisis, many investors learned the hard way that their open-ended investments were not quite as open-ended as they thought.

Indeed the Financial Stability Board recently recommended a series of proposals to address this problem, including disclosure of liquidity positions and, controversially, introducing redemption fees to act as a deterrent to opportunistic or first mover redemptions.

It will be interesting to see whether the FCA adopts any of these proposals in response to the review it has announced in response to the property fund suspensions.

Another recent development in the open-ended world (hedge funds this time) has been a trend towards launching institutional funds with a long initial lock in period.

At the same time, Reits, PICs and other investment trusts have taken steps to improve their ratings using discount management techniques such as buybacks, tender offers and continuation votes.

It seems as though, for investment in illiquid assets, the two models are converging on a semi-open/semi-closed hybrid.

Cathy Pitt is funds partner at law firm CMS Cameron McKenna