Investors could be forced to give property funds six months’ notice to make withdrawals, under plans to avoid managers bringing the shutters down whenever markets turn volatile.
Investors saw a wave of fund suspensions when the Covid-19 crisis kicked off in March, having already experienced the same following the Brexit vote and the financial crash in 2008, trapping £12.5billion of cash.
Property funds which are ‘open ended’, meaning they have unlimited shares that managers have to redeem on request, effectively shut up shop earlier this year, with all 11 currently suspended.
This is because allowing investors to pull out their money immediately en-masse is an almost impossible task for funds invested in properties that must be sold to meet redemptions.
Regulators have therefore proposed introducing a 180-day notice period to create more stability for such funds, which in normal times investors can buy and sell on a daily basis.
Funds invested in shares can usually do this with little difficulty, with rare exceptions, such as the shock collapse of the Woodford Equity Income fund.
But this structure puts managers in a bind when it comes to property, which is by its nature hard to sell fast – particularly in times of trouble, or if you want to get the best price.
This forces them to bar withdrawals altogether if they can’t stump up cash immediately.
To avoid this risk, most investors prefer to gain exposure to commercial property by buying and selling shares in real estate investment trusts, or in ‘closed ended’ property investment trusts, which hold properties.
They don’t suffer the same liquidity problem because they issue a limited number of shares, which are constantly traded on the stock market.
Investors who want to cash in must sell their shares and while these may fall to a discount compared to the value of the assets each share is entitled to, savers can opt to sell out at that level.
Critics of open-ended property funds have questioned the need for them since REITs and investment trust options are readily available.
But the Financial Conduct Authority appears to have chosen the half-way house of imposing long notice periods on investors instead.
It is consulting on the plan until 3 November, and depending on the response it could introduce the new withdrawal rule early next year.
‘Property fund suspensions have occurred with increasing frequency in recent years, including following Brexit and in the current coronavirus pandemic, says the FCA.
‘Fund suspensions exist to protect investors in exceptional circumstances. However, the FCA has seen repeated suspensions of these funds over recent years for liquidity reasons, which suggests that there may be wider problems.’
The FCA says it is concerned that the current structure of open-ended property funds could disadvantage some investors because it incentivises them to be the first to exit at times of stress.
It points out that this can potentially harm those who stay behind if the fund is suspended or assets sold off rapidly, purely to meet liquidity demands.
‘The proposed notice period would allow the manager to plan sales of property assets so that it could better meet redemptions that are requested,’ it says.
‘It would also enable greater efficiency within these products as fund managers would be able to allocate more of the fund to property and less to cash for unanticipated redemptions.’
The FCA believes its notice period proposal could ‘potentially deliver a material increase in returns’ for investors, by making funds operate in a more stable and sustainable way, with more assets invested in property and less in cash.
Christopher Woolard, interim boss of the FCA, adds: ‘We think that our proposals will help further our consumer protection objective by reducing the number of fund suspensions, preventing unsuitable purchases of funds, and by increasing product efficiency for fund managers.’
Ryan Hughes, head of active portfolios at AJ Bell, says: ‘The liquidity mismatch that can occur in open-ended funds has been in sharp focus since the Woodford debacle and property funds are where this problem most often rears its head.
‘There is currently over £12.5billion of investors’ savings trapped in open-ended property funds that are suspended.
‘The FCA’s proposal to introduce a notice period for withdrawals from open-ended property funds is eminently sensible.
‘It will ensure that property fund managers can manage their portfolios more effectively and give them time to sell properties in a controlled way in order to meet redemptions.
‘Perhaps more importantly it should also change the way investors view property funds.
‘Property should be seen as a long-term investment but daily trading on these funds has led to investors assuming they can get their money back whenever they want whereas in reality this has not been the case in many instances.’
But he cautioned: ‘Notice periods won’t call a halt to all property fund suspensions because in times of severe market stress property managers still might not be able to sell properties quickly enough.
‘There will still be the requirement from 30 September this year to suspend funds when there is uncertainty over the values of more than 20 per cent of the portfolio.’
Charles Incledon, client director at Bowmore Asset Management, called for clarity over whether the notice periods mean property funds are excluded from stocks and shares Isas.”
‘At the moment the FCA does not know whether this will be the case. Clearly it would be very damaging if the new rules were to go ahead and HM Treasury subsequently barred property funds from Isas.’
He adds: ‘If these rule changes are made then a lot of financial advisers will just stop recommending open-ended property funds to their private clients. That will make it harder for those investors to diversify their portfolios.
‘The issue of private investors being unaware that they might be locked into a property fund during an extreme economic event could be dealt with by much more rigorous risk warnings on those funds.”
‘The FCA says that they don’t think that their proposals would necessarily prevent funds having to suspend dealings in times of severe market stress. In which case, would the end result justify such a draconian measure?’
Adrian Lowcock, head of personal investing at Willis Owen, says: ‘There is no doubt by putting a six-month notice on the funds they will become unappealing to many investors, especially in a time when investors are used to being able to access a growing range of investments with daily liquidity.
‘Six months is a long time for any investment and the price you get 180 days later could be materially different from the one you expected. However, the notice period will help remove short term investors and would make the asset class less volatile and less susceptible to sell-offs.
‘There will be some disruption, but there are alternatives and the change should present an opportunity for investment trusts and Exchange Traded Funds to come up with a proposition that works.’
Lowcock says normally you get performance data on property funds even when they are suspended, but valuers are struggling to put prices on properties right now so it is not very useful.
He adds that investment trusts holding property perform more like any other shares during crises, so it is hard to tell how the sector is doing from looking at them either. Also, properties are unique and it is difficult to draw true comparisons.
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