Last summer’s open-ended retail fund crisis should be an opportunity to diversify real estate funds rather than replace current structures, an independent report for the Association of Real Estate Funds has found.
The consultation draft of the report by former PwC partner John Forbes said there are “undoubtedly significant flaws” in the structure of open-ended funds, although they should still be available to investors as long as there is demand for funds with daily liquidity.
After the EU referendum in June 2016, seven open-ended retail funds closed trading when there was a surge in redemptions from investors. As a result, AREF commissioned an independent review of fund structures.
Forbes said part of the problem leading to the crisis was a lack of choice for investors. Independent financial advisors are increasingly using broad “model portfolios” that invest in a range of asset classes. This requires a common structure, which means investors who might not need daily liquidity are locked into it.
The report also noted that this structure, combined with technology that makes trading faster, means that advisors can quickly reallocate investments. For example, if an investor’s portfolio allocation to real estate goes from 10% to 8%, that reflects a 20% drop. If there are enough reallocations in a short period of time, as there were in June and July 2016, that could deplete a fund’s liquidity.
Reviewing regulation
Forbes encouraged rethinking the “inconsistencies and complexities” of the regulations behind open-ended funds, which it said had stifled the development of diverse fund structures that could respond to a complex asset class like real estate.
For example, the report noted that the Financial Conduct Authority allows for fund structures that trade in up to six month intervals, but regulations for ISAs, the most popular retail platform for investing in funds, allows trading “no less frequently than bi-monthly”.
Forbes said that if restrictions like these were removed or changed, it could be an opportunity to develop a broad range of investment structures for both investors who want, or need, daily liquidity and for those who do not.
These could include fund structures that allow for subscriptions and deferred redemptions at the same time before resorting to a full suspension, he said. Other funds might have quarterly trading rather than daily trading.
However, he added that bringing in sweeping regulatory changes too quickly could lead to more volatility if it means investors need to take out their holdings as a consequence.
Since the report is in its consultation phase, Forbes has called for managers, investors and intermediaries to continue giving feedback.
He said: “As fund suspensions have lifted and calm has returned to the market, it is entirely possible that some people have changed their views, and indeed others may reach different conclusions after reading this report.
“It would therefore be very helpful if readers can participate as fully as possible through feedback in the coming weeks.”
To send feedback, e-mail karl.tomusk@egi.co.uk or tweet @ktomusk or @estatesgazette
