Within a couple of weeks of the UK’s surprise Brexit vote on 23 June 2016, a plethora of financial services firms, such as Aviva, Standard Life, M&G Investments and Aberdeen Asset Management, had closed their open-ended commercial property funds and applied a wide range of market value adjustments or dilution levies.
M&G, for example, suspended trading in its £4.4bn fund as it noted a ‘marked’ increase in the number of investors rushing to withdraw funds for fear that the value of commercial property was set to dive. M&G said at the time that ‘gating’ the fund would better protect the remaining investors by stopping any other withdrawals and redemption requests.
In an early August press release, the group said this would allow it to raise cash levels in a controlled manner so that asset disposals could be achieved at reasonable values. “M&G aims to reopen trading in the fund as soon as practically possible – once conditions in the commercial property market become more normal and the fund manager has raised sufficient cash in the portfolio,” it said. “Progress on cash levels has already been made with the disposal of seven assets since 5 July.”
Aberdeen lifted its suspension after only a week as it no longer felt the pressure to sell its properties quickly, but the flagship retail property funds of M&G, Standard Life and Aviva remained suspended at 26 August. In a July update, Aberdeen said: “The UK open-ended property funds sector was particularly affected following the referendum, as investors’ concerns about the impact on property values in London and elsewhere increased, and these concerns were exacerbated following the decision by competitor funds to suspend dealing. Aberdeen was well prepared for such uncertainty, with a high level of cash held within the UK Property Fund, the only Aberdeen fund with exposure to these issues.”
This crunch showed investors that what were marketed as open-ended liquid funds, where they could redeem their money at their own choosing, were in fact illiquid. It calls into question whether illiquid assets such as commercial property should ever be placed in an open-ended fund.
Naomi Heaton, chief executive of residential fund provider London Central Portfolio, believes more needs to be done to protect investors.
“UK open-ended property funds were particularly affected by the referendum”
“Open-ended commercial property funds are at odds with the liquidity of the assets they invest in. Large offices with single tenants are particularly illiquid as they are big investments which need to be sold on and that may be difficult in a tough market. Commercial property will be more affected than residential if there is a downturn, because residential is more reliant on global wealth and more long-term investors,”
she says. “You may be forced to sell at a significant discount to market. It is a risk for investors and it is something we saw back in 2009 as well.
“I am surprised that these kind of structures were allowed to continue. Investors should have been made totally aware that they may not have been able to get their investment out when they wanted to. There is a huge desire from investors for liquidity and the chance to exit. The FCA should look at this lack of crystal clear information and whether open-ended funds are appropriate for volatile commercial property.”
A gentle reminder
Indeed, in July 2016, the FCA issued guidance that reminded fund managers of their obligations to investors and looked at how open-ended funds are structured. The note said: “If a fund has to dispose of underlying assets in order to meet an unusually high volume of redemption requests, the manager must ensure these disposals are carried out in a way that does not disadvantage investors who remain in the fund or are newly investing in it.”
Naomi also has harsh words for fund management companies. She says these firms offer “empty promises” through calling their funds open-ended. “They say they are liquid,” she says. “People think they have access to their money at any time but they do not.”
Alan Miller, founder and chief investment officer of investment management firm SCM Private, says it is hard for investors to assess the inherent risk in these funds. “From one lens for liquidity you would say they are high risk but in the other lens for volatility they are low risk. Commercial prices change irregularly and slowly over time,” he says. “There are plenty of funds which have legal warnings to protect investors but wouldn’t it be better to have funds that work properly?”
Like Naomi, Alan does not agree with the fund groups’ management of the post-Brexit scene. “The fund groups and the regulators have not properly addressed the liquidity issue in these funds. The behaviour of the fund groups after Brexit was abhorrent in that they did not treat their customers fairly,” he says. “Are the chief executives fit and proper persons for these roles? They totally ignored the Brexit result. Where were they? Do they have newspapers or were they on a sunbed somewhere or cryogenically frozen? They did not re-price the funds materially to reflect the falls in liquid property stocks or temporarily suspend them immediately. They did nothing and only acted after a run on the funds took place. Something has to be done or they will do it again and again.”
He sees this spreading into other areas. “You have potentially issues in some of the strategic bond funds invested in high yield bonds which at times of stress can be very illiquid. Also with funds with exposure to small companies. If a high-profile manager leaves and you have a high number of redemptions, would the funds be able to cope with that? It is not just property,” he says. “Simply having some cash buffer gives some kind of protection but it is that mismatch between liquidity and the illiquid assets which is the fundamental problem.”
What caused the crunch?
Investors sensing imminent commercial property price collapse made the quick decision to get their money out as soon as possible, a situation that may also have been aggravated by the shift to centralised investment propositions by many wealth managers.
This put pressure on the fund management companies to respond to their requests and provide them with their cash. As ever, too many investors at one time wanting redemption caused a cash crunch, as commercial property assets are not easy to sell at short notice, especially during a period of economic uncertainty.
The funds were therefore suspended to protect the value of the funds and other investors and to give fund management companies time to make appropriate sales.
Rory McPherson, head of Investment Strategy at Psigma Investment Management, picks up the point. “There are other dressed-up illiquid assets, such as unlisted infrastructure, invested in areas such as prisons and toll roads, wrapped up in an investment trust and private equity assets where there are lock-down periods. Fundamentally these should not be for people who want to take their money out when they can,” he says. “They should not be held as part of a daily liquid portfolio.”
The spread of the liquidity crunch clearly reveals the UK’s current nervous economic climate. Investors are twitchy, anxiously casting their eyes around equities, bond prices and commodities for signs of pressure and strain. What will the Brexit referendum vote and continued uncertainty over the timing of the UK’s exit from the EU mean for individual economic sectors and the nation’s balance sheet as a whole?
Commercial property prices and the demand for new buildings and office space are strong indicators of economic health. A drop in asset prices following the vote was a clear sign to many that the wheels of the economic recovery could fall off if private investment, particularly from abroad, seized up. Open-ended property funds were one of the first clear signals that caution was now required.
Despite this, Rory expects the open-ended property funds to remain. “People may take their money out when they realise they were buying illiquid proper bricks and mortar wrapped up into something which offered daily liquidity,” he says. “There may be more disclaimers or health warnings in the future but I think there is enough information for investors to make an educated decision about going into these funds or not. You should look at daily traded volumes, whether the ownership structure is spread out among a number of investors or a couple of institutions. This will give you a steer on how liquid it will trade.”
In the end it may be about how much risk an investor is willing to take. “With a property fund you might look at the cash buffer, but even then you don’t know what the rate of withdrawals is going to be. When you go in you have to accept that when you come out you may not be able to and may not get the price you want,” says Laith Khalaf, Senior Analyst at Hargreaves Lansdown. “If you are not willing to bear those risks then open-ended funds are not for you.”
This article was originally published in the September 2016 print edition of The Review. The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'.