PropertyJul 24 2019

Property funds make millions from cash fees

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Property funds make millions from cash fees

Financial Adviser's analysis of Morningstar data showed the industry could be making up to £16.2m from the practice, despite no actual fund management being required for this part of the portfolio.

The issue stems from the funds' daily liquidity option, which allows investors to withdraw their cash at a day’s notice. 

Open-ended property funds have little liquidity with which to meet redemptions from clients because buildings, regardless of underlying market conditions, take time to sell.

But all 16 funds in the IA UK Property Direct sector offer daily liquidity, which means they allocate as much as 20 per cent of the fund's assets in cash or cash-like instruments, as a buffer against a rush of investors seeking to withdraw funds, as was the case after the Brexit referendum in June 2016 when several funds were suspended.

Data from FE Analytics out last week showed the proportion of cash held in UK property funds doubled from 10 per cent to 20 per cent between January and June 2019. 

And the funds charge a management fee on this holding. The total assets of the funds in the sector was £11.1bn as at June 17, with the median fund being £931.5m in size, and the average management charge being 0.75 per cent.

Among the largest funds in the sector is the M&G Property Portfolio, which has assets of £3.1bn, and just more than 10 per cent of that is held in cash. 

The £2.4bn Janus Henderson UK Property fund has more than 20 per cent in cash and charges the asset management fee on all of the portfolio, not just on the part actually invested in property.

A representative of M&G said this was because the cash element was to provide liquidity and liquidity had to be managed, so the fee was justified.

Representatives of Janus Henderson Investors and Aviva Investors also confirmed the fees on cash for the same reason.

A representative of Columbia Threadneedle said: "The cash position is an important aspect of the entire workings of the fund. It provides liquidity. It also provides the fund manager the ability to find the best assets, as well as an opportunity to reinvest in existing assets."

Financial Adviser examined all 16 funds in the sector, and looked at the primary share class, which is the one advisers can typically buy for their clients. In compiling the data we assumed all of the funds in the sector levied the management fee, as none of those we contacted told us they do not. 

The data shows that, based on fund sizes and charges on June 17, the funds were making £16m from these charges.

James Sullivan, multi-asset fund manager at Miton Optimal, has concerns about the charges levied on investors.

He said: "The investor is being made to pay for the privilege of a flawed concept. Hypothetically, a 5 per cent allocation to a fund in this space may only be giving the investor 4 per cent exposure to the asset class they have selected, therefore an AMC of 0.75 per cent is actually a grossed up fee of 0.9375 per cent on the invested portion of the portfolio.  

"A pretty rich charge at any point in the cycle, let alone where yields are at present."

He added: "I struggle to understand how fund management groups have been able to achieve this from both a regulatory level, and more importantly, a morale one."

The Financial Conduct Authority (FCA) has previously expressed concern about the suitability of the open-ended fund structure for investing in property.

In its consultation paper on investing in illiquid assets in October 2018, the regulator highlighted that holding a large quantity of cash can hurt investors as it is not earning the same return. 

The cash in the funds will be earning interest and this is passed onto the client as part of the returns of the fund. Some funds hold "cash like instruments" such as 10-year UK government bonds, which can be sold so quickly they are almost the same as cash.

The yield on the 10-year UK government bond is currently 0.82 per cent, meaning that some property fund investors may be earning a return of 0.07 per cent on the cash, after paying the standard management fee of 0.75 per cent for the privilege. By comparison the average return in the sector was 30 per cent over the 5 years to July 18.

Jim Harrison, director of Master Adviser, an advice firm in London, said property funds that charge clients for cash holdings were "not acting fairly".

He added he would never put clients into such funds in the first place due to the liquidity issue and would put them in investment trusts instead, which allow clients to trade the shares rather than the underlying investment.

Minesh Patel, an adviser at EA Financial Solutions in London, also said the charges were unfair. He said: "The charging policy is a reflection of the way fund management groups focus on their interests rather than the investor. I do not think it is fair."

But Philip Milton, founder of advice firm PJ Milton and Co, sided with the providers. He said: "They don’t really charge [the management fee] on cash. They charge it on the fund – which happens to hold cash. 

"What might be a better consideration is ‘are these the best ways of holding these assets?' The simple answer, to be frank, is ‘no’. 

"Otherwise tough, you buy a fund, you pay a management fee for the manager’s judgement on how he invests and upon what he subscribes the capital – including cash and allowing for his concerns over suspensions.

"Some might even argue that for many property classes an active decision to hold big cash balances has been positive in that that segment hasn’t fallen in value as would the property assets held."

david.thorpe@ft.com