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FCA opens discussion into illiquid open-ended funds

09 February 2017

The UK financial regulator is seeking views on investing in illiquid assets following the suspension of trading by several property funds last year.

By Rob Langston,

News editor, FE Trustnet

The Financial Conduct Authority (FCA) is seeking views on the practice of investing in illiquid assets through open-ended funds and the challenges posed to managers and investors.

Following the result of the UK referendum on EU membership last year, several property funds were forced to suspend following a flood of redemption requests by investors.

According to Investment Association data, £2bn was withdrawn from property funds in 2016 owing to concerns over the impact that leaving the EU could have on the real estate sector.

During 2016, the average IA Property fund returned 8.19 per cent in 2016 – but this contains a number of international property portfolios. In a bespoke sector made up of funds investing the majority of their portfolio in UK assets, the average fund lost 0.13 per cent over the year.

Performance of sectors over 2016

 

Source: FE Analytics

Indeed, as the chart above shows, the UK referendum result led a steep fall in performance for UK property funds as funds sought to revalue assets as redemption requests flooded in.

Last year’s events have prompted the UK financial services regulator to ask a number of questions of the industry and investors to understand current practices and thinking.

Megan Butler, executive director of supervision – investment, wholesale and specialist at the FCA, said: “We want to engage with fund managers and the investors whose money they manage to understand what problems they think exist.


“Specifically, in the context of open-ended funds we want people to consider how well the current rules address those problems, and what further regulatory intervention might be needed.”

The regulator noted that, while many open-ended funds investing in illiquid assets offer daily dealing, assets were not revalued on a daily basis.

In its discussion paper, the FCA has also asked whether it should take direct action in the market, giving it power to close and reopen funds.

The launching of the discussion paper and events of last year has led to calls for greater education for investors around illiquid assets.

Guy Morrell, manager of the HSBC Global Property fund, said many investors need to be aware of what investing in illiquid assets means for portfolios.

He said: “As we saw in the wake of the Brexit vote, some investors wanted to exit the commercial property sector quickly, but realised that this wasn’t immediately possible.

“I don’t believe that this was an intrinsic problem with property as an asset class, but rather about investors’ expectations around of how quickly they could sell fund holdings in unusual market conditions.”

He added: “Buildings are illiquid and investors need to ensure that prospective returns offer sufficient compensation for this illiquidity.”

Darius McDermott, managing director at Chelsea Financial Services (pictured), said: “This is more about transparency and making sure investors have a fair understanding of what they are buying before they buy it.

“Property is an illiquid asset class but anybody who has been investing for 10 years will remember the last time they closed.

“They closed post financial crisis and shouldn’t be a big surprise to people [that they closed after the referendum].

“What’s important is that investors are aware that it is an asset class that is illiquid.”

Despite the redemptions of last year there were a number of UK property funds that took in fresh money over the period.

According to FE Analytics, the Standard Life Investments UK Real Estate fund, managed by George Shaw and the first fund to suspend trading last year, saw net inflows of £1.2bn for the whole year as pre-referendum inflows offset the later redemptions.


Standard Life Investments UK Real Estate recorded a 5.79 per cent loss in 2016. It reopened later in the year, after implementing a controlled and structured asset disposal programme aimed at raising liquidity to meet future redemptions.

Performance of fund vs sector in 2016

 

Source: FE Analytics

Several other funds also saw inflows over the whole of 2016, including L&G UK Property, SJP Property and F&C UK Property, thanks to a strong start to the year.

Indeed, despite the performance of the funds and the suspension of trading by several firms, advisers continue to recommend the asset class as an important diversifier in a portfolio.

Patrick Connolly, head of communications at Chase de Vere, said “We do recommend property funds and continue to recommend them. Proper diversification can provide consistent income streams.

“What you need to appreciate is that it is an illiquid asset and isn’t something that should be traded.

“The right approach is to hold property and hold it for a long time, which is what we do.” 

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.