The property funds industry may be on the road to recovery after a painful recession, but investment managers have had to face some uncomfortable investors’ truths in the aftermath of the financial crisis.
Fund restructurings have been a recurring theme in the industry in 2014, as managers have either been forced to overhaul vehicles still battling with debt and other legacy issues, or at termination have been compelled to modernise in order to meet a new era of investor demands.
Funds that have received the go-ahead from unit holders for restructuring so far this year include TIAA Henderson Real Estate’s flagship £1.2bn Outlet Mall Fund, SWIP’s £460m Airport Industrial Property Unit Trust and UBS’s previously troubled £627m Triton Fund.
But have funds been able to restructure in a way that keeps investors and fund managers happy? And what tensions have arisen in the process?
Investors are anxious that the mistakes of the previous cycle – particularly highly geared acquisitions of lower-quality property – are not repeated, and want to ensure clear safeguards are built into structures to protect against future crises. As a result, managers are under pressure to deliver returns with lower gearing, and to grant investors greater freedom to pull their money out of the fund when they want.
“Clients want a lot more checks and balances these days,” says Mike Sales, TIAA Henderson Real Estate’s managing director, Europe. “The challenge for a fund manager is ensuring that investors feel safe and happy – while preserving their own freedom to invest.”
The recent wave of overhauls suggests the industry is learning its lessons from the financial crisis. A case in point is Triton Fund, which underwent a raft of changes in July this year. The balanced fund had run into trouble after a combination of high leverage and rapidly depreciating asset values had investors flocking to leave the vehicle.
A freeze on redemptions was put in place in mid-2012 as the result of a redemption queue that grew to more than £500m at its worst point, before it was rescued by a £197m cash injection from a group of new investors.
The restructured fund now includes a range of checks and balances that offer investors greater protection. Redemptions will be provided on a pro-rata rather than chronological basis to prevent large exit queues building up, and unit holders will have the power to vote to remove the fund’s manager in the event of underperformance.
Howard Meaney, who joined UBS in 2012 to manage the then struggling fund, feels Triton struck a good balance between the needs of investor and manager. “We’ve been able to make Triton more robust in periods of uncertainty,” he says. “The previous structure was not that protective of investors, but now that has been resolved. We needed to adapt to the changing requirements of investors.”
However, investors are keen to ensure that their interests are as well-protected as possible – and are becoming more vocal in their demands. It is becoming increasingly common for major fund managers of vehicles that have performed well to approach investors to gauge interest for an additional 10-year term – with the quid pro quo of a fresh structure. This option is being pursued rather than starting from scratch with a new vehicle launch.
“Investors will often be in favour of extending a fund that has been performing well, rather than having to find a new home for their money in a new vehicle,” says Sales. “But if they are going to stay on with the same manager, it is natural for them to want to see changes to corporate governance and remuneration.”
TIAA Henderson Real Estate’s extended its Outlet Mall Fund into a new 10-year vehicle boosted by €160m of fresh equity in April this year, and made a number of critical structural changes. “Fees on our European Outlet Mall Fund are calculated on the fund’s net asset value following this year’s restructure, rather than the gross asset value,” says Sales. “NAV doesn’t include debt, but GAV does. This means the manager isn’t incentivised by the fee structure to ramp up gearing”
The permitted level of gearing on both the European Outlet Mall Fund and the Central London Offices Fund has also been brought down, from 50% to 30% post-extension in order to placate investors concerned about over-leverage, Sales adds.
The only thing that makes investors as nervous as high levels of debt is illiquidity. The prospect of being gated in an underperforming fund alongside other disgruntled investors has emerged as a major concern following the Triton Fund debacle.
Putting in place more frequent liquidity windows, or even converting funds to a semi-open-ended structure to give investors more flexibility, is becoming increasingly common, as is illustrated by Scottish Widows’ £460m Airport Industrial Property Unit Trust. A vote on conversion is due to take place in Q3 this year, and will require the approval of 70% of unit holders to be passed.
So do investors feel the fund management industry has done enough to ensure their interests are protected? For the most part, yes, according to Douglas Crawshaw, senior investment consultant at Towers Watson.
“There is a consensus that property funds have become more investor-friendly as a result of recent improvements to funds, and for the most part, investors feel listened to,” he says. “The shocking thing is that it took something of the scale of the global financial crisis to push the fund management industry to put much-needed safeguards in place”
While both sides appear to have reached agreement over gearing levels and liquidity, one highly contentious issue is the question of giving power to investors to vote out the fund manager in the event of underperformance.
This was not an industry norm in the years before the crisis, but it is becoming an increasingly common feature of funds that are restructuring and extending – even those with strong track records. For example, Legal & General’s £900m Industrial Property Unit Trust, which merged with the smaller £100m Falcon Property Trust in Q3 last year, had a change of manager agreement added at the time of its restructure – despite the fact that the vehicle had outperformed its IPD benchmark on a one-, three- and five-year basis since 1997.
“There is a perception among fund managers that investors are using these clauses as a basis for haggling over fees,” says independent fund consultant John Forbes. “Managers are not happy about giving investors the power to vote them out, but most have accepted it.”
John Gellatly, head of Europe, real estate multi-manager at Aviva Investors, says he is broadly in favour of change-of-manager clauses, but notes that the balance of power between managers and investors is in a constant state of flux:
“About 18 months ago, when the market was weaker, most managers restructuring or setting up new funds would be willing to agree to a change-of-manager clause,” he says. “But now that the market is so strong, I suspect there will be more pushback from fund managers against this. The power has shifted subtly in their direction this year.”
