Commercial property funds are popular with private investors as historically they have provided high dividends with relative price stability. But the announcement yesterday by Standard Life Investments that it had suspended trading in its UK Property Fund has further undermined confidence in the property sector after it was already depressed because of the impact of Brexit. The suspension means that investors are unable to sell their holdings.
This fund, one of the largest open-ended property funds, is an “open-ended” fund – in other words it is a unit trust or OEIC, as opposed to a “closed-end” collective investment vehicle such as an investment trust. In addition, the Standard Life fund invests directly in buildings rather than just in the shares of property companies. Open-ended funds provide daily pricing and investors expect to be able to sell, or buy, at any time. But if there are more redemptions than purchasers then the fund manager has to sell some assets if the sales exceed their liquid holdings of cash or other assets. However selling buildings cannot be done in days. Rather it can take weeks, months or even years to find the right buyer willing to pay a fair price.
So you have a model similar to banks that lend long but borrow short. When there is a run of investors taking their money out, the bank goes bust. Just a few investors cashing in their holdings can cause a panic and although Standard Life reduced the price of units to deter investors, this clearly was not enough in this case. This problem was very apparent in the last financial crisis of 2008/9 when similar property companies had major difficulties and a number closed their doors (for example the Arc European Property Fund went into liquidation).
Property investment trusts do not have this problem. If investors wish to sell they can do so in the market but it will not cause the fund manager to need to sell the assets. The trust might end up with a large share price discount to NAV but that tends to be a temporary phenomenon as large discounts can attract other share buyers.
So private investors should surely avoid open-ended property funds. Why do they buy them rather than the equivalent investment trusts? Probably because retail investor platforms, stockbrokers, wealth managers and IFAs prefer to recommend funds rather than investment trusts for reason you can easily guess.
Property funds are also disadvantaged because they have to maintain large buffers of cash and other liquid assets such as quoted shares to enable them to manage the flow of redemptions whereas trusts do not. In other words their returns might be reduced because they are not all invested in property.
Unfortunately, as we have seen today, the panic among property fund investors has affected the share prices of property companies and the associated investment trusts (who invest both in their shares and directly in property) because there is some anticipation that property funds will be dumping their holdings onto the market at fire sale prices. That might create some buying opportunities in due course.
But why the FCA has not introduced some rules on this matter is rather surprising. Indeed Andrew Bailey, the new chief of the Financial Conduct Authority, has already said there are issues with the structures of open-ended property funds that need to be addressed and that is surely true. Maintaining some liquidity to manage investment flows is one thing but when the basic structure is inherently risky there are bound to be problems sooner or later. Clearly this case is the second time the problem has arisen. Last time open ended funds went out of favour for some time afterwards, but the market unfortunately has a short memory.
Meanwhile Standard Life says it will review its suspension at least every 28 days, but don’t hold your breath waiting. Meanwhile the panic will likely spread to other property funds as investors head for the exit.
Postscript: M&G and Aviva have also suspended trading in their open-ended property funds today. My prediction above almost came true before I finished writing it.
Roger Lawson
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