More than three years on from the vote to leave the European Union (EU), investors remain highly uncertain about the form and timing of the UK’s departure from it. And although the effect of uncertainty on prices could translate into big gains for domestic-facing assets if the picture becomes clearer, it has triggered the return of a familiar problem for investors who hold open-ended UK property funds.
M&G Property Portfolio (GB00B89X8P64), a fund with assets under management of £2.5bn, suspended trading earlier this month. M&G Investments said that it had been subject to “unusually high and sustained” investor outflows in recent months, at a time when Brexit-related political uncertainty and structural shifts in the UK retail sector have made it difficult to sell commercial property. Prudential (PRU) has also suspended a smaller fund that invests in M&G Property Portfolio.
However, concerns centre on other large open-ended property funds and whether these are also at risk of suspension. M&G Property Portfolio was just one of seven open-ended property funds to temporarily suspend trading in 2016, when uncertainty triggered by the vote to leave the EU made it difficult to sell property and prompted nervous investors to withdraw from property funds. Although net outflows from M&G Property Portfolio have been particularly high this year, amounting to about £901m in the first 10 months of this year alone, other funds have also experienced redemption requests, just as properties may become even harder to sell. The news of M&G Property Portfolio's suspension could also prompt investors in other funds to rush for the door and once a fund struggles to sell assets quickly enough to return cash to investors, the suspension of trading becomes highly likely.
Any sign of greater clarity around Brexit could prompt an uplift for UK assets, rejuvenating parts of the UK property market and encouraging investors to put money into or stick with open-ended commercial property funds. But to provide a snapshot of how the funds that suspended trading in 2016 have been faring in less certain times, we have outlined their size at the end of October and the net outflows that they endured over the first 10 months of this year, as well as recent performance.
Commercial property funds suspended from trading in 2016
|Fund||Size||2019 net outflow to end October||Cash allocation (%)||Year to date performance, as of 6 December (%)|
|Aberdeen UK Property||£1.4bn||£610m||12.7||-6.5|
|Aviva Investors UK Property||£542m||£235m||30.9||-6.3|
|Janus Henderson UK Property||£2.2bn||£236m||16.7||2.7|
|Canada Life UK Property||£381m||N/D||8.9||-0.5|
|M&G Property Portfolio||£2.5bn||£901m||5||-7.5|
|Standard Life Investments UK Real Estate*||£1.8bn||£107m||16.3||-1.2|
|Threadneedle UK Property||£1.2bn||£322m||6.3||0.5|
Source: fund providers, FE Analytics, Morningstar. Size and cash weighting as of end October unless otherwise stated
*Size and cash position from end of September
Only two of the seven funds that suspended trading in 2016 made a positive return in the past 11 months and they have also experienced redemption requests from investors. Data is not available for Canada Life UK Property (GB0032040254), but the other funds have had to deal with net outflows of between £107m from Standard Life Investments UK Real Estate (GB00BYPHP643) and £901m from M&G Property Portfolio. Relative to their overall size, Standard Life Investments UK Real Estate and Janus Henderson UK Property (GB00BP46GG64) have had more modest outflows, amounting to less than a tenth of their assets at the start of this year.
But other funds look more vulnerable. Aberdeen UK Property (GB00BTLX1G31), the second worst performer in the group, experienced net outflows of £610m over the first 10 months of this year, according to fund data company Morningstar. This represents a large chunk of the fund – around 30 per cent of its assets at the start of 2019. Although its outflows have been lower, Aviva Investors UK Property (GB00BYYYZ110) is also roughly a third smaller than at the start of this year. And net outflows from Threadneedle UK Property (GB00BQ3G0Z13) have left it around 20 per cent smaller.
Based on these figures, Aberdeen UK Property and Aviva Investors UK Property look most exposed to potential difficulties in meeting investor redemptions if these persist or escalate.
But it is also important to note how much cash each fund has been holding in recent months. Funds that hold high levels of cash may sacrifice some yield and return because they are not fully invested, but this can also be a good way to meet redemptions in difficult times. If commercial property is proving slow or difficult to sell, property fund managers can use their cash holdings to meet investor redemptions.
Low cash levels arguably heightened the need for M&G Property Portfolio to suspend trading: it had around 10 per cent of assets in cash over the summer, but by the end of October this had fallen to just 5 per cent – possibly because its managers were using the cash to meet redemptions.
Many of this group of seven funds have been running reasonably high cash levels. Aviva Investors UK Property had more than 30 per cent of its assets in cash at the end of October, while Aberdeen UK Property, Janus Henderson UK Property and Standard Life Investments UK Real Estate had double-digit allocations. Threadneedle UK Property had the lowest allocation to cash of just 6.3 per cent of its assets.
A substantial allocation to cash arguably lessens the likelihood of further suspensions, but this also depends on whether investors rush for the door and how long outflows last. And because a high cash allocation can be detrimental to performance you should consider why exactly you want to hold such a fund.
Ben Yearsley, director at Shore Financial Planning, says: “Property continues to act as a diversifier, but the next few years are likely to see little or no capital growth. With many open-ended UK direct property funds holding upwards of 25 per cent cash, total returns could be in the 2 to 3 per cent range for a while.”
Although investors have some idea of how more popular open-ended property funds are faring and are positioned for redemption requests, the suspension of M&G Property Portfolio is a reminder that exposure to illiquid assets comes at a price and should be monitored closely.
“While dealing suspensions are clearly unwelcome, investors should always be prepared for this risk, particularly with the most illiquid and long-term asset classes,” says Peter Toogood, chief investment officer at fund ratings agency The Adviser Centre.
Louis Tambe, fund analyst at FE, adds: “It shows that liquidity issues can creep up on investors. [Redemption requests] might have started due to Brexit worries and continued due to challenges in the retail sector, forcing [M&G Property Portfolio] to sell assets and lock in losses, which further compounds the issue. This shows that liquidity needs to be monitored regularly – not just ahead of key events.”
Fund suspensions can cause difficulties when it comes to changing or rebalancing your overall portfolio as you cannot change allocations to the affected funds. If a fund manager is forced to sell assets to raise cash this could also be detrimental to performance, although the impact is likely to be minimal if you have a diversified portfolio and limit on your allocation to such funds.
And fund suspensions can be successfully managed: all the property funds that suspended in 2016 went on to resume trading within about six months, and UK commercial property could benefit from any Brexit-related bounce in sterling.
M&G has also reduced M&G Property Portfolio’s annual charge by 30 per cent while it is suspended and investors in it will continue to receive income payments.
The Financial Conduct Authority supports suspending funds from trading in certain circumstances, so there could be more of these in future. But if you wish to avoid the uncertainty of a fund you hold being suspended, one option is to get exposure to property via a closed-ended investment trust instead.
But this also incurs some issues. Investment trust managers are not forced to sell assets to meet redemptions when investors take their money out of them because you cannot sell your shares in a trust back to it. If you want to dispose of your holding you have to sell it to other investors on the secondary market. But if a trust is out of favour this will push its share price down so, although you might be able to dispose of your holding in it by selling your shares, you may have to do so at a great loss. However, as we discussed last week, depressed share prices can represent an opportunity for patient investors who see merit in the underlying assets.
Twelve out of 14 direct property investment trusts were trading at a discount to net asset value (NAV) as of 9 December, according to broker Winterflood. And nine of these were on a wider discount than their 12-month average rating, which perhaps reflects the gloomy sentiment of recent months. The average discount to NAV for these trusts was 7.7 per cent, compared with their 12-month average of 5.7 per cent.
Custodian Reit (CREI), by contrast, was on a 10.4 per cent premium, the same as its 12-month average rating. And LXI Reit (LXI) was on a premium of 13.9 per cent, higher than its 12-month average rating of 10.7 per cent.
Analysts at Investec have made the case for investing in Ediston Property Investment Company (EPIC), whose shares trade at a wider discount to NAV than their 12-month average of 13.3 per cent. This trust is exposed to the retail sector, but invests in areas other than the beleaguered high street.
If you prefer the convenience of an open-ended fund and fewer liquidity worries you could invest in a fund that holds both physical properties and shares in property companies. BMO Property Growth and Income (GB00BQWJ8794), for example, had around a quarter of its assets in direct property at the end of October, alongside significant exposure to property shares listed in the UK and Europe.