UK property fundamentals remain attractive despite last year’s Brexit concerns and, contrary to widespread fears, open-ended funds can be a good way to gain exposure to the market area, according to F&C’s Guy Glover.
The manager, who has headed up the F&C UK Property fund since its launch in 2010, was one of the handful of UK direct property fund not to suspend trading shortly after the EU referendum, when a mass exodus from the sector led to vehicles from Henderson, Threadneedle and M&G among others announcing temporary suspensions.
Performance of funds in 2016
Source: FE Analytics
While the manager can understand the reasoning behind their decision, he says his fund was largely protected from potential outflows due to its different investor base and its bias towards smaller properties.
“We aim to attract long-term money to property from the wealth management community – some DFMs but mainly wealth managers and IFAs,” he explained.
“We actively avoid large, institutional and multi-manager holders entering the fund because they would then be controlling the liquidity.
“One of the most important aspects of the property fund is who you’re invested alongside. You have an inherently illiquid asset and what you want to do is ensure that your fellow investors are there for the medium-to-long term and have the same investment time horizons as us.
“We are more ex-London, long-term, secure regional income. What [the fund] is doing is trying to deliver straight-line growth over a period of time. With a more defensive portfolio and a long-term portfolio, and also with a different investor base, the challenges of 2016 with Brexit were different for us.”
Following the events of last June, however, a number of investors have turned pale on the sector, especially given the remaining uncertainty surrounding Brexit. According to data from the Investment Association, property funds saw retail outflows of just under £2bn last year, compared to a net retail inflow of £2.7bn in 2015.
Glover says that, despite concerns, the UK property market offers investors a wealth of attractive fundamentals so long as they are selective.
“What is the state of the UK property market? There are still very much two markets out there. You have central London which, despite what’s been happening, is still trading at 20 per cent above its 2007 peak,” the manager explained.
“Yields are quite tight in central London but, actually, when you compare central London yields with the likes of Paris, New York and Singapore, the difference is rents are local, and London potentially faces some challenges over the medium term with a slow bleeding of jobs to Europe.
“We’re not writing off London, we’re just saying there are some challenges there which I think are acknowledged by the whole market.
“Outside of London, valuations are between 15 and 20 per cent below the 2007 peak. It might not be cheap, but if I can go out and buy a building in an M25 town which delivers me 6 per cent in income for nine years with a little bit of growth, that feels about right.”
However, there has been some debate as to whether open-ended funds are the best way to access the property sector, with critics citing illiquidity and high cash weightings as reasons to stay away.
In an article published last month, Cohen & Steers’ Rogier Quirijns told FE Trustnet that this year’s tricky investing environment is the “canary in the coalmine” for investors in open-ended property funds.
“At first, the outflows were based purely on sentiment. Now, the fundamentals will catch up and that will happen slowly,” he warned.
“Open-ended funds also have to hold a lot of cash for liquidity purposes, which people pay for. The cash levels are ridiculous.
“If I invest in a fund I want to know what I’m paying for and, in this instance, I would be paying these people to hold cash. My returns would also be significantly lower [compared to a listed securities property fund]. You end up with a huge cash drag, which is horrendous.”
When it comes to the debate between holding open-ended and closed-ended property funds though, Glover says both types of investment vehicle are worthy of a place in investors’ portfolios.
However, he urges investors to understand the difference between open and closed-ended property funds, as well as REITs, and how they can expect them to perform over the long term.
“People should be looking for property with an open-ended structure to provide long-term diversification in an asset class which isn’t massively correlated with equities and bonds. It just provides something else within their portfolios,” the manager continued.
Performance of sector vs indices over 10yrs
Source: FE Analytics
“There is no right or wrong way of holding property, the question you have to ask is what the end client wants. It’s all about suitability, making sure the end investor knows what they’re getting into and how it’s likely to perform.
“We know REITs can provide short-term volatility and they’re more correlated to the stock market. That doesn’t make them an unsuitable vehicle.
“Investment trusts have a similar issue where they trade at a discount or premium to NAV. As long as the underlying investors knows what they’re holding at any point in the cycle, it’s absolutely fine. As far as we’re concerned, we believe they all work for different types of investors across the market.”
PAIFs were dealt a blow last month when the FCA released a report on illiquid assets and open-ended investment funds.
While it pointed out that exposure to illiquid assets can offer strong long-term returns and asset class diversification, it warned that open-ended funds that hold such investments can experience difficulties should investors wish to sell out quickly.
“Many funds offer daily dealing opportunities to investors, but hold assets that are not revalued on a daily basis. This creates a tension, as assets cannot be sold in a day to meet daily redemption requests,” the report states.
“If managers cannot determine an accurate and up-to-date valuation for assets in the fund, they cannot be sure they are offering a fair price to investors wishing to sell. So, if the market for the underlying assets is affected by sudden, severe changes in conditions, leading to price falls that are not fully reflected in fund valuations, some investors might be able to sell their holding for more than it is worth, disadvantaging the remaining investors in the fund.”
Glover welcomed the report as it allows investors to make more informed decisions about what they’re buying into.
“[The FCA’s] comment was they understand why people use them, they’re not banning them, they provide great diversification and they’re a source of income. But they did question whether we could improve the structure of open-ended funds out there,” he explained.
“As far as we’re concerned, some of the key themes they were picking up on – such as potentially splitting very large institutions from the retail investors out there – we’ve done that already in this vehicle.
“Having big asset allocators with large multi-managers moving in and out of the fund is not something we would partake in. With some of the product evolutions they’ve been looking at, we have built them into this product from day one.
“The FCA discussion document will be discussed quite widely across the industry over the next six to nine months but the changes are likely to be evolutionary rather than revolutionary to the structure of the product.
“Anything which actually serves the end investor better is great for us.”
Since its launch, the £322m F&C UK Property fund has returned 34.41 per cent compared to its sector average’s return of 63.62 per cent. However, it must be noted that the IA Property sector consists of funds holding property shares and overseas assets, which will of course perform very differently.
Had an investor placed £10,000 into the fund at launch, they would have so far received £2,014.99 in income alone.
Income earned from fund since launch
Source: FE Analytics
The fund has a clean ongoing charges figure of 0.87 per cent and yields 3.3 per cent.