The FCA should carry out a comprehensive review of “flawed” fund regulations and give retail investors a greater choice of products, John Forbes’ independent report on last summer’s open-ended fund crisis has found.
Investors in retail funds have been restricted to daily trading although there are some who neither need nor want that level of liquidity, the report commissioned by the Association of Real Estate Funds said.
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.
A final version of the report was released this morning after a consultation draft was published at the beginning of April. The conclusions were broadly the same.
The report found that fund managers had “sought to treat investors fairly” during the suspensions, adding that there could have been more clarity about what funds can do in periods of high redemptions.
Although there are “undoubtedly flaws” in the structure of these retail funds, the report said that bringing in regulations that would prevent daily trading would be dangerous if it meant investors had to redeem their holdings. Any changes should be brought in gradually and with input from the industry.
Forbes said: “Those who choose to continue to invest in daily traded products need to be fully aware of the cost of liquidity, the risk that liquidity might not be available when they want it, and the differences between funds.”
John Cartwright, chief executive of AREF, added: “We are ready not to only embrace positive change, but to drive it. Our work has already started and we look forward to working with the regulator, other industry associations and market participants across the board to ensure that we can be better prepared for future periods of uncertainty.”
Forbes report’s key recommendations
Regulations review
The Forbes report encouraged a rethink of 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 such as real estate.
For example, the report noted that the Financial Conduct Authority allowed for fund structures that trade in intervals of up to six months, but regulations for ISAs, the most popular retail platform for investing in funds, allows trading “no less frequently than bimonthly”.
New models could include a fund structure that might temporarily suspend or defer redemptions while staying open to new subscriptions. Others might have quarterly, rather than daily, trading for investors who are currently paying a price for liquidity they do not want.
The industry should work with the FCA on a “comprehensive review” of these regulations, Forbes said.
Valuations review
Open-ended funds need a review of how underlying assets are valued. In particular, the lag between valuations and sales means that in a falling market, by the time an asset is sold, the value will have fallen and exiting investors have been overpaid.
In a rising market, incoming investors have been undercharged as values grow.
With RICS’ standards update due this year, Forbes recommended that it review its valuation methodology, looking at how to address forward-looking valuations.
He has also encouraged the FCA to review its regulations on market value adjustments for underlying assets, which respondents said were ambiguous with regard to whose responsibility they were and in what circumstances they should be allowed.
Communication
AREF should take a more active role in explaining fund products to investors and their proxies, and ensure it does this without favouring any one model or manager. This is particularly important, Forbes said, if funds make different decisions on whether to suspend or adjust their portfolios’ market value during a period of high redemptions.
With financial advisers and managers having a better understanding of the funds, there would also be more scope to move from one type of retail fund to a range of funds with different structures and targets
Product development
Although the report was not about the EU referendum, it said the event could be used to address a lack of diversity in retail products in the same way the global financial crisis led to new funds for institutional investors.
However, it added that bringing in sweeping regulatory changes too quickly or without input from the industry could lead to more volatility if it prompted investors to take out their holdings.
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