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Will investors be forced out of property allocations?

Will investors be forced out of property allocations?
  Morningstar analysis suggests the UK’s commercial property sector will become unviable for retail investors

Retail investors may ultimately turn away from open-ended property funds despite having returned to the sector following last summer’s turmoil, analysts have warned.

Last week Columbia Threadneedle became the first fund group to return a previously suspended open-ended vehicle to offer pricing. The firm cited a “continued trend” of net inflows as the reason for the move.

However, Morningstar analysis has suggested that UK commercial property investment will be hindered by a combination of Brexit, regulatory intervention and a lack of suitable vehicles – making further allocations unviable for retail investors.

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The FCA is due to publish a paper in the coming weeks on last summer’s raft of fund gatings. Simon Molica, portfolio manager for Morningstar Investment Management Emea, said addressing the liquidity mismatch in open-ended property funds could force retail investors out of the space.

“We don’t expect a strong intervention, but the FCA is doing a lot of work and it could lead to a change,” he said. “If it does [force a move] to non-daily dealing it will rule out a large part of the market.”

Retail investors may have fewer alternative options than they think, according to Mr Molica, who said a wholesale shift away from open-ended vehicles to the closed-ended space would not be viable.

He suggested Real estate investment trusts (Reits) would see greater price volatility as a result of the shift, in turn making exposure less desirable to cautious or income-focused investors.

“At the moment, people use income from property as an alternative. Taking it from Reits [would be] a much more volatile short-term ride. So people will be wary of how they got that income exposure and consider Reits as equity-like instruments.

“For those building portfolios – to be able to populate the same kind of exposure to property will be harder.”

Morningstar’s views have been supported, in the short term, by some fund selectors’ investment decisions. In the summer, discretionary manager Whitechurch sold out of its open-ended property holdings entirely, and continues to hold a negative view. But managing director Gavin Haynes denied the space was fundamentally “broken”.

Whitechurch classifies the funds as equity holdings, rather than part of a property allocation, in keeping with most peers.

Mr Haynes acknowledged that share price volatility did have to be accounted for, but said this could be manageable and stressed the importance of looking through short-term risk.

“Both [open-ended and closed-ended funds] have a part to play and for a balanced or cautious investor property is a valid asset class. The short-term outlook is just weaker,” he said.

Mr Molica is also cautious over the prospects for property in general: “It’s becoming increasingly difficult to justify the continued strength of UK property in a post-Brexit world. On almost all metrics, the market appears on the higher side of fair value, plus the risk underpinning Brexit leaves a bleak risk-adjusted backdrop.”