Against: open-ended funds

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Investing in buildings

Against: open-ended funds

After the EU referendum in June last year, the suitability of open-ended funds for investing in property was called into question when numerous commercial property funds were forced to gate investors.

But we had been there before. You do not have to stretch your memory very far back to recall the trading suspensions that came in the wake of the 2008 financial crisis. What was supposed to be a rare event, brought about by extreme market circumstances, has happened twice in the past 10 years. 

In June 2016, the experience had an immediate impact on advisers’ purchases of property investment com panies. Data from Matrix Financial Clarity for Q3 and Q4 2016 revealed the Property Direct – UK sector was the most popular for adviser purchases. 

Advisers are recognising that the closed-ended structure of investment companies has benefits for investing in illiquid assets such as property. This is not to say they are immune from market sentiment: the average discount of companies in the AIC’s Property Direct – UK sector widened to 12 per cent at the end of June 2016. But investors were not prevented from buying or selling shares during this time. The sector’s discount quickly narrowed and it stands at a premium of 5 per cent at the time of writing.

The risks of investing in illiquid assets via an open-ended structure have also caught the attention of the FCA. In February this year, the regulator launched the Illiquid Assets and Open-Ended Funds discussion paper about “some of the risks created when consumers use open-ended funds to gain exposure to assets that may be difficult for the fund manager to buy, sell or value quickly”. 

The key advantage of the closed-ended structure for investing in property is that managers do not have to worry about inflows and outflows of investors’ capital. Closed-ended managers can take a long view, sit out any volatility and focus on the long-term performance. Open-ended managers, on the other hand, need to retain a sizeable portion of the portfolio in cash to meet redemptions, sometimes as high as 20 per cent or more, meaning investors could suffer from cash drag. 

The use of gearing is another benefit of the closed-ended structure. When applied sensibly, gearing increases exposure to the asset class, enhances income and enables managers to move more nimbly when they see compelling investment opportunities. 

When it comes to performance, over one, three, five and 10 years to the end of June 2017, the AIC Property Direct – UK sector has returned 21 per cent, 42 per cent, 116 per cent and 71 per cent, respectively, based on share price total return. This compares to 5 per cent, 16 per cent, 35 per cent and 14 per cent returned by the average open-ended property fund in the Morningstar Property Direct – UK sector over the same time frames. So, on performance grounds alone there is a compelling case for investing in property through the closed-ended structure. 

Laura Thomas is PR and marketing manager of the Association of Investment Companies