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UK Property Funds: Barbarians at the Gate

Published: July 7, 2016 by Rory Maguire, Fundhouse UK

It appears that democracy is squarely to blame for clients being unable to get their money out of many of the UK direct property funds. Who would have thought that the vote last Thursday would leave us with this sort of cause and effect?

Nobody, we hope. That’s because it has little to do with Brexit, in spite of the headlines. The real reason involves stating the obvious: these funds buy bricks and mortar property that takes weeks to buy, after involving parties like solicitors, estate agents and surveyors. And, so it follows, that if these funds need to sell the same property, it takes just as long. Surely, then, when there are more sellers than buyers of the fund, these funds must grind to a halt eventually?

The canary in the coal mine was way before Brexit, in May this year, when fund managers started to shift from offer to bid pricing, effectively creating an exit cost of 5% for investors who wanted their money back. Fund groups wanted to stop all the outflows because they knew that suspending fund redemptions was a reluctant last resort. Gating, unlike an exit levy, has stronger self-fulfilling negative sentiment and, lets face it, a desire to want your money back even more. The queue of (angry) sellers is only getting longer now.

As advisors to our clients on this issue, we have looked pretty silly for quite some time. Back in December 2014, we decided to suspend all our property ratings on the back of these liquidity concerns and the heightened state of property valuations. And in May this year, when the exit fees became commonplace, we wrote to our clients again, suggesting that gating may be the next step. Yet, all that happened, between December 2014 and April 2016, is that direct property kept on going up in what was close to a straight line with very little volatility or downside. It did double the return of Sterling equities, bonds and listed property over the time! But then came May and finally July. And we fear that when these direct property funds eventually re-open, the value of client’s investments will be even lower.

What we really question is the apparent mind-set that it is ok to operate in a state of wilful blindness. Collective failure, it seems, is fine so long as we are all in this together. But as financial services professionals, we are all in the business of generating reputational capital and I am afraid that we have done a disservice to our clients and industry here. The issue of a daily traded fund, which needs weeks to sell its underlying investments, is so obvious. We all knew.

These funds willingly took on the massive inflows when buyers significantly outnumbered sellers. It smacks of greed, to knowingly accept such large and frequent inflows that could not possibly be serviced as outflows if they left at the same speed they arrived. Besides suspending trading on these funds, maybe the fund groups should suspend their fee too. And that would be the smallest of consolations, but will go some way to repairing our aggregate reputations.