When I first started writing about UK open-ended property funds in 2019, I wondered which would come first: a final regulatory intervention into the sector or the closure of some of these once mighty funds.
The news that fund house M&G is to close its open-ended property fund, which was one of the biggest on the market, didn't come as a shock last week, because Aegon and Aviva had already started winding up their respective property funds. But it did raise questions about the other funds in the sector, which collectively still has billions invested.
From October 19, M&G stopped daily dealing in its Property Portfolio fund and started the winding up process. That could now take up to 18 months. Neal Brooks, M&G's global head of product & distribution, explained the decision.
He said it's down to "declining retail investor interest across this fund structure" as well as "uncertainty around their future composition".
The first part of this is obvious: funds in this sector have repeatedly suspended over recent years because of Brexit (in 2016) and then the pandemic in 2020. That has damaged investor confidence. Outflows thus increased and performance has been patchy to say the least, particularly after repeated UK lockdowns hammered the commercial property sector.
Every time a fund re-opened after suspension, it also triggered outflows as investors decided the game was up. "The writing has been on the wall" since then, says Ryan Hughes, head of investment partnerships at AJ Bell.
Wealth manager St James's Place is just the latest to suspend its property unit trust on October 23, citing the challenge of having to sell properties quickly to generate cash for redemptions.
The second reason M&G mentions is a nod to the regulator, which is still cogitating the right path ahead for open-ended property funds, whose investors want daily dealing on assets that don't lend themselves well to frequent valuation.
This so-called "liquidity mismatch" has plagued the industry, so the FCA has been consulting on ways to solve it for a number of years. Suggestions include locking in investors for longer periods, an idea hampered by the fact investors are now used to frequent trading via investment platforms and apps.
While there’s been no conclusive decision by the regulator, its comments gave the impression open-ended property funds were doomed to extinction eventually.
Instead, the FCA started building the idea of the "long-term asset fund", a nod to other (more resource-endowed) countries like Norway and their sovereign wealth funds. Pension funds, which were big buyers of property funds in their heyday, could also keep exposure to the asset class but without the pain of daily dealing requirements. Some providers such as Schroders, Aviva and BlackRock have already created new LTAF products, a category whoch came into being in November 2021.
As we can see from the table below, only two property funds are above £1 billion in assets. And the performance over nearly four years has been volatile.
The Three-Day Rule
It may now feel like a long time ago, but the pandemic is still having its impact. We don't know whether hybrid working is really here to stay, but the post-pandemic period has led to radical changes in the way we use our towns and cities, which house most commercial property assets. This makes returns harder to come by, but it also makes predicting performance nigh-on impossible. At one point, property fund managers were heralding a post-pandemic era in which companies relied on much bigger warehousing capacity to prevent supply chain dislocations like the ones seen at the start of the lockdowns themselves. But the conversation has clearly moved on.
This situation may also be correlated with the end of the housing boom. In the glory years investors wanted some access to property as an asset class – be it commercial or residential – because performance figures were impressive. Some financial advisers even cautioned that investors had too much exposure to property, given home ownership is essentially a leveraged bet on house prices. These calls usually went unheeded as people chased returns.
Today, retail investors can pick and choose the parts they like from the "commercial property" umbrella via specialist investment trusts and exchange-traded funds (ETFs) focused on warehousing, logistics, storage and ecommerce. To pick an example from the FTSE 250, Tritax Big Box (BBOX), a distribution centre specialist, now has a market cap the same size as M&G Property at its peak, of £2.5 billion.
As M&G’s Neal Brooks said yesterday: "When we launched this strategy in 2005, we – alongside our peers – provided access to an asset class that had historically been unavailable to long term savers in a pooled structure. The market has since evolved."
As we await the FCA's final report, it feels like the debate has moved on now anyway. Investors have voted with their feet and funds have shrunk, and the latest iteration of the Conservative government under Sunak and Hunt has actually pushed in the other direction and now wants pension funds to have exposure to riskier, less liquid private markets to give their returns a lift. It's difficult to tell where that leaves property.
How Do Property Funds Work?
Property Authorised Investment Funds (PAIFs) are open-ended funds that invest directly in commercial property, including big buildings such as offices, shopping malls and apartment blocks. Such investments are inherently less liquid than open-ended funds that invest in equities: stocks can be sold in moments, buildings can take years.
There is, however, a catch. The problems of this structure were seen in the immediate aftermath of the 2016 Brexit referendum when most open-ended property funds were forced to suspend trading. It was feared that Brexit would cause a property crash and investors would flood out of these funds. Without enough cash to hand to meet a wave of investor redemptions, the funds gated temporarily to avoid being forced into a firesale.
This process happened again in the pandemic when funds gated to stop a wave of redemptions. But by then many investors had already had enough. Will M&G’s decision now lead to a fresh wave of redemptions? We'll keep an eye on the data and let you know.
