Regulator questions set up of property funds

Regulator questions set up of property funds

The European regulator has raised concerns about a liquidity mismatch in property funds, arguing the problem indicated a “structural vulnerability” in their set up.

The latest statistical report from the European Securities and Markets Authority said real estate funds were exposed mostly to illiquid physical assets, which took time to sell, yet a large section of the market offered daily dealing to investors.

About half of commercial real estate funds — the largest category of property funds — also offered daily liquidity, the report said.

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According to the regulator the combination of illiquid, physical assets and promises of daily dealing created a “mismatch across all time periods” which showed “structural vulnerability” as the time taken to sell the property assets and give investors back their funds were “not aligned”.

The report, which focused on EU Alternative Investment Funds, found real estate funds to be the sector with the second largest percentage of retail investors, who accounted for more than a fifth (21 per cent) of investors in the fund.

Esma found the level of property funds offering daily to monthly dealing had dropped from 63 per cent in 2017 to 47 per cent in 2019 — a sign fund houses were mitigating some of the risk — but argued the liquidity profile of real estate funds still pointed to a mismatch.

The watchdog also said the problem could be mitigated by cash to some extent — adding that cash had increased for most real estate categories in 2018 — but Esma noted the cash buffers were still significantly lower than the mismatch that could arise.

The issues surrounding illiquid assets in open-ended funds with daily dealing was highlighted in the UK late last year when M&G was forced to suspend its Property Portfolio after a “unusually high and sustained” period of outflows.

The fund house said structural shifts in the UK retail sector had made it difficult to sell commercial property and so it was unable to meet the requested redemptions.

In the aftermath the Financial Conduct Authority promised action "within weeks" and later issued a joint report with the Bank of England which floated proposals to curb the "mismatch" between redemption terms and funds' liquidity.

Such solutions included a shift in the way the liquidity of funds was assessed to reflect the mismatch alongside a lower asset price for investors who pulled their cash quickly.

The M&G suspension mirrored a series of events in the aftermath of the EU Referendum in 2016 when a number of open-ended property funds, including M&G’s, were suspended.

Tom Sparke, investment manager at GDIM, said: “The decreasing level of return has been a headwind for [UK property funds] and has damaged their reputation — the liquidity issues have only exacerbated this.

“That said, when the dust has settled on Brexit and the UK looks to be on a stable footing economically I think they will become appealing once again as their diversification benefits are considerable.”