Real estate faces a “fundamental long-term problem” as the issues around open-ended retail funds, which caused mass redemptions following the Brexit vote two years ago, have not been resolved.
John Forbes, the former PwC partner who was charged with writing an independent report following the crisis that saw six major funds with £16.6bn in assets suspend trading, has highlighted the lack of progress the FCA has made in pushing the industry forward.
Open-ended retail funds offer daily liquidity despite holding illiquid assets. After the EU referendum, a panic-driven surge in redemptions left several funds with depleted cash levels.
In April 2017, Forbes, commissioned by the Association of Real Estate Funds, recommended that, although open-ended funds should not scrapped despite “significant flaws”, regulations should allow for more complex structures that reflect the complexity and illiquidity of real estate.
Two years on, Forbes said: “Everything I said in my report is still valid. You may want to put your money into REITs or daily-traded funds, but you shouldn’t have to have everything invested in things that are liquid.
“We need to get to a product where people don’t need daily liquidity in everything they do. Unless we find a better answer, then there’s a really fundamental long-term problem for the real estate industry.”
He said the problem is that the FCA has yet to respond to the report. The regulator carried out a consultation last year on illiquid assets in open-ended funds, which ended in May 2017. It said it would issue a response “later in 2017”, but this has not materialised.
Forbes added: “There is a feeling that there is an opportunity for the development of new types of funds here, but until the regulator says what the rules are going to be no one wants to move forward to launch anything.”
The FCA has not responded to a request for comment.
The open-ended funds crisis – has anything really changed?
What went wrong on 4 July 2016?
The fear of falling property values after the EU referendum triggered a panic among investors. Within three days in early July, six major open-ended funds suspended trading to as their liquidity plummeted.
Trading resumed over time in 2016, with Aviva Investors the last to re-open its fund on 15 December. It was suspended for 163 days.
What has changed since then?
The size of the funds has fallen 17% from £16.6bn to £13.7bn after managers made significant disposals in their non-core stock. M&G sold £718m of risky assets in its property fund during its suspension, a move it said would “preserve the integrity and future of the fund”.
Aviva Investors UK Property Fund, whose portfolio has shrunk from £1.6bn to £938m since June 2016, similarly sold assets that were outside its core areas of London, Manchester, Birmingham and Cambridge.
Andrew Hook, fund manager at Aviva, said: “The Aviva Investors UK Property Fund continues to follow a disciplined investment strategy, focusing on a small number of core locations where we are deeply embedded and where our deep relationships drive execution and add value.”
Are investors still panicking?
Investors were spooked by falling values in 2016, which led to four consecutive quarters of net negative inflows into property funds. In the second quarter alone, property funds lost £1.2bn of investment.
Although things improved in 2017, property funds still saw an annual net outflow of £137m. It was the only asset class that experienced net outflows last year.
Some optimism seems to have returned, however, with Q4 2017 and Q1 2018 showing net inflows of more than £200m each into property funds.
Do funds have a contingency plan?
With the referendum triggering the panic in 2016, fund managers have built up cash reserves in case there is another surge in political volatility and panic during the Brexit negotiations. Around 20% of both the Janus Henderson UK Property PAIF and the Aberdeen UK Property Fund’s portfolios are cash.
A spokesman for Janus Henderson said: “We are holding in excess of 20% of the fund in liquid assets, which is the aim over this period of Brexit uncertainty.”
Otherwise, the company added, it is “very much business as usual”, with no change to its diversified core strategy apart from a three and a half month period of sales to build up cash levels.
How are the funds performing?
If you had invested on 4 July 2016, Janus Henderson’s fund would have returned close to 14%, above the direct UK property average of 12%, according to figures from Morningstar. The Threadneedle fund has similarly outperformed the average.
Aviva has lagged behind at 5.3%, with the rest hovering in between the extremes.
Although there has been steady growth since 4 July 2016, funds have only recently passed the highs they reached two months before that date. Taking 4 May 2016 as a benchmark, direct UK property funds have returned 8% since then, and the six funds lag behind at an average 4%.
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