Property funds of funds are emerging in the UK, giving investors with smaller allocations access to the indirect market, plus the chance to diversify their portfolio and spread risk
First came the creation of indirect property funds; next comes property funds of funds. This growing sub-sector of the indirect property market has been a natural extension of both equities and bonds markets, and property fund managers do not intend to miss out. “It is the fastest growing part of our business,” says Nick Cooper, managing director and head of indirect investment at ING Real Estate Investment Management. Its UK fund of funds management activities have just passed through £1bn in just over three years.
The same story comes from other UK-based fund managers such as Schroder Property Investment Management and Henderson Global Investors. All are expanding their business by offering smaller pension funds — with smaller allocations — indirect access to a large, diversified pool of property.
The presence of an established non-listed fund market has put the UK at the heart of the growth in property funds of funds. But as the continental fund market matures, funds of funds are expected to spread, as is the positive knock-on effect on the secondary market for trading units in such funds.
The sector has two approaches, often confusingly both labelled fund of funds. The first, more popular, multi-manager approach involves investing on behalf of single clients in a series of indirect funds, while a true fund of funds pools a number of clients’ capital to invest across various vehicles.
Smaller pension funds have often been wary of investing in property, despite its low volatility, as their smaller allocation for the sector could not guarantee diversified exposure; a lesson they learned in the 1970s and 1980s. “Then, they were caught in relatively non-diverse portfolios,” says David Hemmings, director of property portfolio management at Henderson.
The multi-manager approach
Cooper adds: “If a pension fund has £30-60m to invest in property, then at that size it is very difficult to buy a diversified portfolio. So they end up with a stock-picking portfolio.” Multi manager accounts, or funds of funds, surmount this problem.
A £500,000 investment in ING’s Osiris fund of funds, launched at the end of October, demonstrates this. It provides exposure to 12 funds managing more than £8.6bn of property, with the risk spread across 450 different properties and 2,200 tenancies. Osiris has grown to £100m, with investments of between £500,000 and £30m. The pension fund pooling scheme, which is similar to a unit trust, is open-ended, with a quarterly redemption facility and a £100,000 minimum investment.
“The target is simply product performance in line with the HSBC APUT [Association of Property Unit Trusts] index, after costs,” says Cooper. “It is very low risk and is designed to give investors access to property market performance.”
The low-risk approach is also spread across managers, which will be a comfort for investors, whose alternative is to place their property allocation into a balanced fund. “That means you are at the risk of one manager, and redeeming £50m out of a £600m fund is also not that easy,” says Hemmings. Henderson invests in four to seven vehicles for separate account clients.
Fund managers buy into indirect vehicles on behalf of clients either at the launch stage or, increasingly, on the secondary market. The secondary market is an informal one; HSBC is the only non-fund manager to provide a match-making service between investors and funds. Generally, fund managers have taken the lead in creating a liquid market.
“We tend to offer [a match-making] facility but don’t charge for making our own market,” says Ian Mason, head of real estate at Merrill Lynch Investment Managers, referring to its £1.1bn Merrill Lynch Property Fund (MLPF), which has an annual turnover of around £125m. “If you do not offer liquidity, investors’ only other option is to redeem their investment,” adds Mason.
In addition to its MLPF vehicle, Merrill Lynch has become only the second fund manager to launch a true UK fund of funds. It hopes to build its open-ended UK Property Fund of Funds, which is a jersey unit trust, up to 500m.
Otherwise, secondary trading in fund of fund units is more about “dealing with people rather than a screen” says Hemmings. Fund managers approach vehicle managers for sectors they want to get exposure in, while investors have used Henderson’s managers or advisers to carry out straight sales of stakes on their behalf, or in some cases to put stakes up for auction.
Teams such as Cooper’s act more as analysts, viewing vehicles as stocks and giving them buy and sell ratings. This is helping the secondary market to throw off its image of being for distressed sellers only. “An investor may have had a good run with a fund and want to sell, while we are taking the counter view,” says Cooper. “For instance, we have been quite positive about the industrial sector for a while.” Investors may also want to sell as they reweight their portfolios.
Secondary trading in the UK is supported by organisations such as APUT, which now provides quarterly statistics on its member funds and high-level analysis comparable with other asset classes. APUT now collaborates with European non-listed vehicles organisation INREV, which should help establish best practice and transparency throughout the European non-listed sector.
Managers want to buy into a spectrum of vehicle styles — closed and open-ended, limited partnerships, UK and Jersey unit trusts — and new vehicles are engineered to cope with this need for liquidity. For example, limited partnerships are now unlikely to include pre-emption rights for existing investors, which have previously scuppered the chance for open trading. However, the due diligence process for sales by closed-end funds is still convoluted.
A wall of money
“Demand in the secondary market is no different to demand in the direct market, in that it is being driven by the weight of money,” says Cooper. Jenny Buck, head of property fund of funds at Schroder Property Investment Management, which manages £500m for 10 clients, agrees: “There is a wall of money but it is hard to make acquisitions because there are not that many sellers.”
It is also a relatively new market and the liquidity of some funds, particularly closed-end ones, is untested. Guy Morrell, director of research and indirect investment at HSBC Specialist Investments, says: “Investors should appreciate that some vehicles can be less liquid than the underlying property.”
Fund managers often seek “matched bargains”, for which they negotiate to circumvent the high entry price of buying into investors’ chosen funds. Hemmings says that while secondary investment is broadly the same as putting money into direct property, matched bargains can offer chances to get better value.
Inevitably, investors in good funds are less keen to sell their stakes. However, Phil Ellis, head of institutional property funds at Morley, which manages £750m of multi-manager accounts, says: “It can be easier to find something at less than the usual entry price if you look at specialist funds.”
One concern is whether fund managers should provide fund of fund services, as there may be conflicts of interest between running balanced and specialist vehicles. For example, Merrill Lynch’s vehicle will invest in its own balanced fund. However, Mason defends this approach, saying: “MLPF is a major core fund with a good track record; it would be difficult not to invest in it.”
Prices in the secondary market are set in relation to net asset values, based on monthly valuations. Investors have to pay fees at two levels, but Hemmings says that because larger funds often charge lower fees, this kind of investment is not always more expensive.
| Talk but no action on pan-European funds of funds |
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The growth of fund of fund-style investing has been much slower on the Continent, hampered by a relatively immature fund market and different regulatory and tax regimes. |
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Managers that have tried to set up funds of funds have found themselves ahead of their time. Last September German fund manager REAL IS planned to launch a pan-European, €250m fund of funds, giving investment exposure to €1bn of underlying property, but a spokesman says there was not enough interest to proceed. However, the fund manager may revive its plans, as it believes the idea is a good one. |
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Danish institution ATP also considered its international programme as a fund of funds.”We had talks with a number of Danish investors, but they were not ready at that time,” says manager director Michael Nielsen. |
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ATP has €278m of its €500m international allocation left to invest in European indirect vehicles. Its investments include €15m in Apollo International and €22.5m in the Henderson UK Retail Warehouse fund. “In a few years we will build up our next fund; whether it will be alone again, we have not decided,” says Nielsen. |
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When funds of funds do emerge on the Continent, they are likely to pull together capital from one country, which could then be invested in tax-efficient vehicles for investors from that domicile. |
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“There are 12 core European countries and each has its own definition of pan-European,” says Ian Mason, head of real estate at Merrill Lynch Investment Managers. The tax liabilities of a pan-European range of investors would be too complictated when investing several sources of capital in different funds. |
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But UK fund of fund managers will definitely be coaxing clients onto the Continent with time. Jenny Buck, head of fund of funds at Schroder Property Investment Management, says: “Some clients with higher income requirements may need a higher yield than UK property. Generally, more stock will begin to emerge in Europe.” Other barriers include the lack of sufficiently robust benchmarks. |
