The Financial Conduct Authority (FCA) has been warned about an overly “simplistic” change to the rules governing open-ended property funds.
The FCA is currently consulting on changes to the rules governing funds that invest in assets with little underlying liquidity.
These funds include those that invest in physical property and private equity.
Cedric Boucher, chief executive of Hearthstone, which runs a residential property fund, said one recommendation from the FCA was too simplistic.
The FCA recommended funds should suspend redemptions when there is uncertainty about how to value a minimum of 20 per cent of the portfolio.
The regulator’s aim is to ensure that initial investors who withdraw capital from the funds do not have an advantage over those who withdraw later.
By suspending redemptions early, this would ensure, according to the paper, that all investors in the funds are treated equally.
The recommendation came after investors in physical property funds suffered in the immediate aftermath of the Brexit vote, as they were unable to meet redemptions quickly enough, because they couldn't sell the underlying property in time.
Mr Boucher said: "Some of the new rules proposed seem somewhat arbitrary and might not always work when nuanced decisions need to be made at pace. In particular, the proposal for mandatory suspension where the standard independent valuer has expressed material uncertainty about immovables that account for the value 20 per cent of the scheme properties.
"As with any simplistic rule and deterministic rule, it is unlikely to work well when decisions need to be made in a complex and fast-moving environment. How does the valuer assess whether 18 per cent or 21 per cent of a portfolio are difficult to value?
"When does normal uncertainty become 'material'? How can this be implemented consistently across the industry?"
He added that the FCA's proposal to include funds of funds that invest in illiquid assets in the new enhanced disclosure rules for open-ended funds that invest in illiquid assets could actually make the problem the regulator is trying to solve worse.
Theoretically funds of funds should have ample liquidity, because the manager can simply withdraw capital from the underlying funds.
But the regulator's consultation recommends that such funds are also likely to be vulnerable to withdrawals and liquidity issues because the funds in which they are invested in could have to close to investors wanting to take money out under the new rules.
Mr Boucher said: "Extending some of the rules to fund of funds investing in illiquid funds on one hand seems logical, but on the other hand will exacerbate the problem as fund of fund investors might be forced sellers at a time when such investors could and might want to provide stability in the market."
David Scott, an adviser at Andrews Gwynne in Leeds, said he expects problems experienced by funds with illiquid assets to get worse as sentiment among investors continues to be negative.