My September 2016 column highlighted the concerns I had over the outlook for the UK commercial property market and the effects the Brexit vote had on the vehicles retail investors typically use to access the asset class: open- and closed-ended funds.
It would appear I have drained my well of ideas dry by revisiting a topic that I covered only six months ago. At that point I was relatively sanguine on the outlook for the asset class, forecasting modest single-digit returns for 2017 – the majority coming from yield. This continues to seem a not unreasonable expectation, so what has changed? Nothing in terms of outlook, but I have fundamentally changed the way we access the asset class.
Post the Brexit shenanigans of open-ended funds gating, swinging prices and running quasi-cash funds with a bit of property on the side, I have become convinced the only way retail investors should access this asset class is through a closed-ended strategy. There are some very good managers within the open-ended property space, but I believe they are now hamstrung by the very vehicle they are managing.
At times of stress these funds do not provide the liquidity investors seek, and to countenance this lack of liquidity 30 per cent cash weights are not uncommon. Changing attitudes to liquidity, and the forthcoming FCA’s consultative paper regarding illiquid assets and open-ended funds, have many managers of these products running scared. This leads to the end investor not gaining full access to the asset class, and many open-ended funds have exceptionally punitive exit penalties.
Paying a swinging price on a vehicle that is 30 per cent cash is distasteful, and in my view is to the benefit of the manager when an annual management charge and dilution levy is paid on this cash.
The closed-ended fund has its disadvantages, particularly in times of stress, but a manager should always be able to get a price and I would countenance that it is a long-term holding. The advantage the manager has during stressful periods, where fearful investors may seek to redeem, is that there is no permanent impairment of capital as the portfolio is closed; or in other words, the fund manager is not a forced seller.
The share price may be hit in the short term, but historically they have always recovered. Over the longer term the shareholder benefits from a fully invested portfolio.
Closed-ended funds, including real estate investment trusts, allow skilled asset allocators to target their exposure as opposed to taking a blanket approach.
I do not see illiquidity as a negative, as long the vehicle is structured for this. In fact, it has been the closed-ended world where new launches, especially within the specialist space, have been most prevalent.
I have trouble remembering the last open-ended property specialist fund to launch, although I am sure someone will be along to point one out.
We have recently been researching and investing in property long-lease, closed-ended IPOs such as LXI. These investments provide a steady, inflation-linked and hopefully uncorrelated return that any real return investor should find attractive.