Barely a month has passed since the Financial Conduct Authority closed its consultation on open-ended funds holding illiquid assets, conceived in response to the property fund gatings of June 2016.
By the time its findings are made public, history may have repeated itself: recent weeks have suggested Brexit-related stresses are again making themselves felt in the world of real estate investment.
December brought news that two funds – Columbia Threadneedle UK Property and Kames Property Income – had moved from offer to bid pricing after outflows increased. Those moves wiped 6.1 and 5.7 per cent, respectively, off investor returns, and marked the first time that funds had switched pricing in this way since the run-up to the EU referendum.
Subsequent data from the Investment Association showed that the UK Direct Property sector saw £228m in outflows in December, a notable change from the negligible flow activity seen for most of 2018. On February 8, the FT reported that the FCA had begun demanding daily updates from funds on outflow activity as of December.
One argument says that a second round of suspensions would not prove a major problem for the sector. Advocates of the open-ended structure say the suspensions of summer 2016 showed the system working as it should: funds were closed until the tremors affecting the asset class subsided, which they duly did just a few months later.
Regulators, however, believe more improvements are necessary. In fact, their conclusion is that fund suspensions should become more common. The FCA has proposed rules requiring providers to suspend portfolios if there is “material uncertainty” about the value of 20 per cent or more of their physical assets.
The watchdog sees this as a better solution than the status quo, which has seen many open-ended property funds build up sizeable cash buffers that they can use to meet redemptions where necessary. One problem with these buffers, as the regulator sees it, is they provide a first-mover advantage to “well-informed” investors. These fund selectors can sell a portfolio before a suspension or dilution adjustment, leaving others to wait it out. High cash levels also reduce a portfolio’s performance and yield.
The counter-argument is perhaps being made at this very moment. As redemptions from property funds increase, it’s perhaps only these cash levels that are staving off another set of suspensions. And whatever the merits of gating, a series of closures at a time when investors are already nervous about UK assets is likely to compound the damage for the sector.
So what is the solution? One answer is investment trusts holding physical property, but such structures don’t lend themselves well to the model portfolios increasingly favoured by advisers. As a result, others are favouring a hybrid approach.
Data from our sister publication Asset Allocator – a newsletter for discretionary fund managers – shows that many DFMs combine bricks-and-mortar open-ended funds with those that buy property equities. Some providers offer such a mixture in a single fund: the BMO Property Growth & Income fund, for example, holds around a quarter of assets in physical property, with the rest in shares.