Investors should expect to see more UK commercial property funds suspend dealing as a consequence of the UK’s vote to leave the European Union, according to investment analysts, although they should not necessarily fear a return to the very difficult conditions that came with the global financial crisis.
Earlier this week, Standard Life Investments announced that it had suspended trading in its Standard Life Investments UK Real Estate fund (and its associated feeder funds) due to “exceptional market circumstances”. The strategy has assets under management of £2.9bn.
“The decision was taken following an increase in redemption requests as a result of uncertainty for the UK commercial real estate market following the EU referendum result,” a statement from the asset management house said. “The suspension was requested to protect the interests of all investors in the fund and to avoid compromising investment returns from the range, mix and quality of assets within the portfolio.”
Returns of open-ended UK direct property funds in 2016
Source: FE Analytics
Standard Life Investments added that the suspension would end "as soon as practicable" and the decision will be reviewed every 28 days.
The fund recently saw its value written down by 5 per cent after the Brexit result "negatively impacted" valuations for UK commercial property. Property funds run by Aberdeen, F&C and Henderson went through similar adjustments to their value.
As this article was being written, it emerged that Aviva Investors has also suspended trading on the £1.9bn Aviva Investors Property unit trust because “the extraordinary market circumstances, which are impacting the wider industry” have led to a lack of immediate liquidity for the fund.
And as this story was literally being entered into FE Trustnet’s content management system, it was announced that M&G has gated the M&G Property Portfolio and its feeder fund as investor redemptions have “risen markedly because of the high levels of uncertainty in the UK commercial property market since the outcome of the European Union referendum”.
Laith Khalaf, senior analyst at Hargreaves Lansdown, said after the Aviva suspension: “The dominoes are starting to fall in the UK commercial property market, as yet another fund locks its doors on the back of outflows precipitated by the Brexit vote. It’s probably only a matter of time before we see other funds follow suit.”
“The problem these funds face is that it takes time to sell commercial property to meet withdrawals and the cash buffers built up by the managers have been eroded by investors heading for the door, both in the run-up to the EU referendum and in the aftermath.”
By their very nature, open-ended property funds have a liquidity mismatch: investors have the ability to withdraw cash every day but it can take months for the fund to sell the underlying properties. In order to safeguard against this, portfolios tend to have a high cash weighting but these can get eaten into during periods of high and constant redemption requests.
The suspensions are the first to be seen in the UK commercial property space since the financial crisis, when heavy losses (UK direct property funds lost about 35 per cent, on average) and concerns over the economic outlook sparked a wave of redemptions from the sector.
Performance of open-ended UK direct property funds between 1 Jan 2007 and 30 Jun 2009
Source: FE Analytics
Figures from the Investment Association show that property funds were hit with a net retail outflow of £360m in May (ahead of the referendum).
Although investment trusts do not face the liquidity mismatch of open-ended funds, data from the AIC shows that the average member of the direct UK property sector is now trading on a 14.3 per cent discount to net asset value. This is far below the one-year average premium of 2.3 per cent.
When it comes to the issue of trading suspensions, the Investment Association said the use of them shows that the “stringent” regulations laid out by the Financial Conduct Authority to protect investors are working.
“Fund investors’ interests are protected in a number of ways and the ability to suspend redemptions is one of the most important tools because it prevents fund managers from being forced to sell, in this case property interests, too rapidly and helps them achieve a better outcome for all their clients,” the trade body said.
Indeed, Andrew Bailey – who has been the chief executive of the FCA for less than three days – suggested that open-ended property funds’ liquidity mismatch problem needs to be looked at.
“We have got open-ended funds that hold illiquid assets that don’t revalue naturally. Suspension is designed into these structures – they are not a panic measure. The purpose is to create a pause to allow that process [of revaluation] to happen. That’s sensible, but of course from a conduct point of view, we do not want to see differential treatment of investors. We are in very close touch with these firms,” he said at a press briefing on Tuesday morning, ahead of the Aviva and M&G suspensions.
“It does point to issues that we need to look at in the design of these things, because it comes back to my fundamental point about holding illiquid assets in open-ended funds that revalue and are required to be revalued. My own feeling is ... that we will need to come back and look at those.”
It remains to be seen whether other fund groups will follow Standard Life Investments, Aviva Investors and M&G in suspending open-ended direct property funds but some suspect this could be likely.
Ben Willis, head of research at Whitechurch, said: “The problem is that the headlines that are generated [around property funds] are a self-fulfilling prophecy. My biggest fear is that it might have a knock-on effect.”
“People see the headlines, see that certain funds have suspended trade and, if they are going to sell out, they’re going to look to the other funds that are open and to sell their positions there. It creates this domino effect because, if fund groups start seeing big redemptions in their fund they’re going to suspend trading.”
Tilney Bestinvest’s Jason Hollands says the issue highlights how the open-ended structure is not best suited to illiquid assets like commercial property and may draw more attention to the advantage of taking exposure through closed-ended vehicles like investment trusts.
However, he does not think the situation today should prompt as much concern as the financial crisis.
“The uncertainty around Brexit is undoubtedly a challenge for the property sector but this is not a post-Lehman Brothers style moment when the whole financial system faced collapse and the supply of credit - key to property transactions - was in doubt,” Hollands said.
“The Bank of England has set out its readiness to provide vast amounts of liquidity and interest rates look set to be cut. Talk is moving decisively in favour of a pro-growth rather than a tax hiking Budget. The stock market has weathered Brexit bettered than many predicted and successful corporate bond issues this week from British American Tobacco and Brown Forman (the producers of Jack Daniels) suggest the sterling credit market remains open for business.”
Darius McDermott, managing director of Chelsea, adds that the decision to suspend trading in a fund to protect investors is “understandable”, even if it does cause some frustration for those looking to sell (or even buy) them.
“If investors need to access their investments in other property funds in the very near term, they may wish to do so sooner rather than later as some others may follow suit. However, investors should be aware that there will be very high exit charges for doing so, as most physical property funds have already had 'fair value adjustments' and moved from offer to bid pricing,” he said.
“But I would emphasise that long-term investors in the asset class, who would otherwise not change their investments, should not be panicked into making a move. Property is still a good diversifier in an overall portfolio and yields on these funds may also increase, which will be a positive for income investors.”
Willis adds that property funds still look “okay” on a fundamental basis in the near term, which may bring some comfort to long-term investors, but think that money is still likely be heading for the doors in a short-term reaction. It must also be keep in mind that accurately valuing UK real estate will be a lot more difficult until more clarity emerges over the UK's exit of the EU.
“Fundamentally you could argue that the asset class provides attractive income but the prospects become more uncertain on the medium term because a lot of the rental growth on property is probably down to the UK economy,” he said.
“Obviously since the vote, the UK economy has been downgraded and GDP forecasts have been lowered, so people think that’s going to have a knock on effect on property. But that’s not going to be immediate, that’s going to be in around a year’s time.”
