CPDAug 25 2020

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
  • 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
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What the FCA's paper means for property funds
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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.

Over the past few years, retail has not been favourable as big online retailers, such as Amazon, has ravaged the high street, whereas demand for warehousing has been buoyant for similar reasons.

A hasty rush for the exit when these funds are reopened ignores this longer-term attraction and for many professional investors. 

Industrial property is perhaps the most cyclical, while office space - at one time, one of the most dependable sectors, is now looking uncertain, as Covid-18 causes all businesses to reassess their need and desire for expensive city centre offices.

Therefore, open-ended commercial property funds have a very useful role to play in a diversified investment portfolio, where the returns and correlation are very different to other asset classes.

Holding commercial property within an investment trust structure, which is quoted as an Investment Company with share capital, introduces equity market correlation which neutralises many of the uncorrelated benefits of the open-ended structure.

In an article for FTAdviser in July, I wrote of the returns from global equity markets, the correlation of this to Real Estate Investment Trusts and the very stable returns from open-ended property funds.

There may be liquidity difficulties and a risk of fund suspension during times of high redemption demand, but for the longer-term investor, and more likely an income investor with only a moderate risk appetite, the benefits are clear.

A hasty rush for the exit when these funds are reopened ignores this longer-term attraction and for many professional investors.

They still offer an attractive, inflation proofed (rents rise in real terms), income generating, uncorrelated asset class with lower volatility.

History lessons

The concept of gating with respect to Oeics and unit trusts first came into focus during the credit crunch in 2008.

At the time of the Lehman’s collapse, investors sold out of the asset class in droves, as cash became king and those funds invested in illiquid assets, such as commercial property, quickly ran out of funds.

As the credit crunch eased, the funds re-opened and investors realised that the attractions of commercial property remained as a recovery play and the demand for redemptions quickly dissipated. Consequently, nothing changed.

But then investors had another wake-up call when the Brexit vote returned an unexpected Leave result on 23 June 2016 and property fund gating started shortly after.

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