What the FCA's paper means for property funds

  • To understand the reasons why property funds have gated
  • To be able to explain the long-term diversification benefits of property
  • To be able to grasp what the FCA's recommendations might mean for client portfolios
What the FCA's paper means for property funds

The property market may have opened up post-lockdown but when it comes to open-ended property funds, these are still firmly gated. 

Investors cannot request redemptions, nor can they make new investments into these funds.

It is a situation that has cause the regulator to launch an investigation to this development, which has now occurred three times in the past 20 years - mostly in recent years.

As a result, the FCA issued Consultation Paper CP20/15 on 3 August 2020, asking for views from the industry by 3 November 2020 as to what should be done.

In this consultation paper, the FCA hinted that it is thinking of removing the daily dealing facility of such funds and replacing this with a 90 to 180 day notification period for redemptions.

Initial commentary in the newswires has focused on the fact this would make the funds inadmissible for Isas, and may also cause issues within self-invested personal pensions, thereby leading some to suggest they should be wound up.

However, before these investment vehicles are consigned to the scrapheap, it is sensible to also look at the attractions of why investors, professional and private, have invested in the past.

The fact these funds are structured as Non-Ucits Retail Schemes means they are subject to fewer restrictions than Ucits funds.

Commercial property as an asset class first entered the mainstream universe of the retail investor in the 1990s. Many were launched by insurance company asset managers, with a portfolio of assets hived off from life funds to produce a retail product available to the masses.

They were welcomed with open arms because they provided a means for the small investor to gain exposure to an uncorrelated asset class which was different to equities, bonds and cash, outside of a life insurance wrapper.

Many commentators have strong opinions that the only structure that should be authorised for retail commercial property exposure should be a closed-ended investment trust, where redemptions simply involve selling the shares and do not potentially trigger an asset sale.

The share price of the investment trust will simply fall to a discount to the net asset value and the fund manager has no need to disturb his portfolio for reasons of redemptions.

Different sectors, diverse performance

However, this view misses an important point. Open-ended commercial property funds have very little influence from short-term movements in the equity market, or the bond markets for that matter.

The value of the underlying assets is dependent on the overall demand for commercial property, whether that be offices, warehouses, retail or industrial.

This is driven by economic growth and the prosperity of businesses who wish to occupy premises. The valuation of a property is influenced by this business demand but also the quality and location of the property and the yield or rent that is attainable in the locality.

While there is a connection to the wider economy and therefore a cyclicality, there is also a longer-term secular link to the economic outlook for the principal type of tenant.