The Financial Conduct Authority (FCA), the City watchdog, is looking into more ways to deal with the problem of open-ended commercial property funds. Many of these unit trust funds are currently suspended from daily dealing because of the impossibility of valuing the buildings the money is invested in, so investors must wait for their money if they want to get out.
Financial Conduct Authority (FCA) comments made recently about the suspensions point to it taking another look into this problem, a “fundamental mismatch at the heart of unit trusts” – known in the financial services industry as open ended-funds – relating to commercial property investments.
An open-end property fund is a diversified portfolio of pooled investor money that can issue an unlimited number of shares. The fund owner sells shares directly to investors and redeems them as well. These shares are priced daily, based on their current net asset value.
The problem arises when the values cannot be ascertained and as these funds often use leverage to enhance returns, there usually isn’t enough cash in the funds to deal with redemptions. In time of crisis, like this coronavirus epidemic, and both the Brexit vote and the financial crash of 2008, properties need to be sold to effect redemptions. But being illiquid assets this cannot be done quickly, hence the need to lock-down these funds.
Industry experts are arguing that open-ended funds, where money is coming in and going out daily, are totally unsuited to illiquid investments like commercial property, which by the nature of these funds, must be valued daily, monthly or quarterly and are impossible to sell in a hurry.
So the FCA has moved a step closer to ending the daily dealing practice in these commercial property unit trusts and is looking for a way to structure these funds in a such a way as would be fair both to those investors who wish to leave, as well as those who want to remain invested.
Whenever there’s a rush for the exit in property funds, as there was with the Brexit vote in 2016, and the crash of 2008, fund managers cannot cope with the demand for redemptions and instead they have no choice but to close the funds to with drawls until property values return, they can sell some properties, or they can raise sufficient cash in other ways to meet sale orders. In the meantime it leaves investors worried and unable to access savings.
This problem can arise with other equity investments besides property: a good example is the recent crisis with the Neil Wordford portfolio that had invested in not so easily deal-in stocks, obscure small and more risky companies and some off-market private investments. Woodford, a star investor who fell to Earth, attracted around £10bn of investors’ cash to his funds before it all went pear sharpened, investors getting back 50% of their investment, if they are lucky
The FCA is to consult on the problem with these open-ended property funds over the summer and it will see whether the long-term investor interests would be better served if their liquidity promises were to be “better aligned with the liquidity of the underlying property assets”, which in practice would mean the end of daily dealing in these funds.
Moira O’Neill from Interactive Investor is quoted as saying:
“There is a perfectly good structure for investing in illiquid assets – investment trusts. They are traded on the stock exchange so there is a ready market which buyers and sellers can access and the trusts themselves don’t have-to sell assets to meet redemptions.”