Property fund reform “is something that needs to be looked at”, according to Premier’s Simon Evan-Cook says, but industry commentators remain mixed on whether the current system in place is the right one.
Property funds are coming under increasing scrutiny in the wake of the recent Brexit vote, as most of the top groups have had to sizably cut the value of their underlying holdings and subsequently suspended trading in an effort to stem outflows from their ‘bricks and mortar’ portfolios.
Managers, it seems, were taken by surprise by the sheer scale of requested redemptions both pre and post the referendum result, despite efforts to build up cash buffers. As the below graph shows, inflows were already dropping ahead of the EU referendum.
Assets under management of IA Property funds prior to EU referendum
Source: The Investment Association, CreditSights
Standard Life was the first to suspend trading of its UK Real Estate fund, followed by Aviva Investors Property Trust and the M&G Property Portfolio.
They were swiftly joined by Henderson, Columbia Threadneedle and Canada Life, while others, including Aberdeen Asset Management, imposed heavy discounts on dealings.
Many funds have been hit by this trend, as the graph below shows, with many seeing their performance plummet in the wake of the shock Brexit result last month.
Performance of sector in 2016
Source: FE Analytics
In fact, it’s the first time since the financial crisis that property funds have had to drop their value so heavily – though most agree the situations are fundamentally different.
In a note published earlier this week, Jim Wood-Smith from Hawksmoor says the similarities are a loss of confidence and a lack of liquidity, with the separating factor being that of ‘subprime’: banks had invested untold billions into funds worth less that the “square root of zip”.
“This time around, property is not conspicuously overvalued, nor are funds and institutions stuffed with worthless paper,” he said.
“What we have is a crisis of an inappropriate investment vehicle. Daily pricing and daily liquidity are simply incompatible with an illiquid asset. As ever, no-one worries about this when the money is rolling in.”
But this time around, it seems that reform could actually be discussed.
Given the impact trading suspensions on property funds during the global financial crisis had on investors, many including Financial Conduct Authority (FCA) chief executive Andrew Bailey, are openly criticising and questioning the procedures in place.
Performance of sector during global financial crisis
Source: FE Analytics
Among the industry specialists interviewed by FE Trustnet, scrapping daily dealing appeared a popular solution.
Evan-Cook, senior investment manager at Premier, says monthly dealings could be the way to go, as it would “encourage the right kind of long-term investor”.
“We have some sympathy with the calls that open ended funds should have longer delays between dealing points so perhaps daily is too frequent,” he said.
“If the industry moved to monthly dealing on commercial property funds then we would welcome that.”
Another agreeing that monthly dealing could be something for the FCA to look into is Tilney Bestinvest’s Jason Hollands, who says a longer dealing delay could give managers a better chance to see trends of inflows/outflows earlier, allowing them more time to plan its response.
“I do think there should be a question-mark as to whether such funds really require daily dealing, monthly dealing would give managers a much better line of site as to whether cash buffers are going to come under pressure and to plan an appropriate course of action, which might include suspending dealing,” he said.
But, he also admits that “I think we have to recognise that current market conditions are a very unusual set of circumstances that require an unusual set of actions.”
This is the argument put forward by those who believe the system, while flawed, should remain in place, providing investors are aware of the risks.
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, says that while monthly dealing might be a preventative measure, it would not solve the problem altogether.
“I’m not sure a move to monthly or quarterly dealing, say, would actually solve the problem,” he said.
“Indeed it might create an even bigger bottleneck as orders back up in a queue to one point. There is no silver bullet with this, the problem is inherent.”
He proposes a new option, which builds on the current system of suspending funds when outflows become too much.
“A universal framework for suspending funds and then progressively allowing periodic trading at pre-announced price (that reflects market conditions and as and when possible) in an orderly manner would be desirable”, he said.
So will any reform take place? While potentially frustrating and inconvenient, the suspensions were put in place to protect investors and are seen by some to have managed to do this in current extraordinary conditions. 
As the Investment Association said last week: “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.”
“Suspension is a mechanism that is laid out under stringent FCA regulations, and when it is employed by one of our members, it shows that the regulations are working as they are supposed to.”
Nonetheless, Andrew Bailey has hinted that one of his first tasks in his new role as chief executive of the Financial Conduct Authority will be to look at whether any changes need to be made to the structure of open-ended property funds.
Investor awareness, rather than wholesale reform, could, in the end, be the route to take.
While Evan-Cook (pictured) says highlighting just the liquidity issue could be a problem, as it could lead investors to worry less about other risks, he adds the issue is far more wide reaching.
“We need to do a much better job of investment education as a country,” he said.
While things may or may not change, the overriding sense is that investors need to be better educated before taking the plunge.
Hargreaves Lansdown’s Laith Khalif said: “As with any investment there are risks and potential benefits, investors just have to weigh them up and make an informed, considered decision.”
