So the M&G Property Portfolio Fund has been suspended and speculation is mounting as to who could be next. I’ve often heard the expression “investing is child’s play” and thought if only… but sadly this scenario does remind me of a nursery rhyme my children loved, the three little pigs.
I don’t want to trivialise what is a very worrying time for investors, who once again are trapped in an open-ended property fund after the suspensions of 2008 and 2016. But clearly the structure of daily-dealing property funds is fragile and not fit for purpose. In this particular case, the fund could not withstand outflows due to “Brexit-related political uncertainty and ongoing structural shifts in the UK retail sector”. Rather like the little pigs’ houses made of straw and sticks, which collapsed after a bit of huffing and puffing.
We’re well aware that managers of open-ended funds sometimes need to sell assets quickly to meet redemptions, and with property that just isn’t possible. In contrast, investment companies have a closed-ended structure and are listed on an exchange where their shares are traded. The fund manager does not have to worry about meeting redemptions, so as long as the exchange is open, investors can buy and sell, although that doesn’t mean they will like the price and in distressed markets discounts will widen.
Despite these structural advantages, I still meet wealth managers and advisers who tell me they prefer the open-ended structure as they can trade at net asset value (most of the time). I can’t understand this. Looking at the average performance of open-ended property funds in the IA UK Direct Property sector to the end of November 2019, they have lost 2% over one year and returned 10% over three years, 17% over five years and 64% over ten years, according to Morningstar. In striking contrast, closed-ended funds in the equivalent AIC sector, Property – UK Commercial, have returned 3% over a year, 17% over three years, 38% over five and 139% over ten. And investment companies have outperformed over all those periods on a share price basis too.
High levels of cash have clearly had an impact on the performance of open-ended funds, with the average cash level standing at 14% at the end of October. L&G UK Property had the most cash (28%) and in contrast the now suspended M&G Property Portfolio held 5%. But it’s not just a question of cash drag: looking at fund inflows and outflows clearly shows that open-ended managers are forced sellers of property to meet redemptions at exactly the time when prices are low. This year alone, to the end of October, they have seen outflows of £2.2bn. On the contrary, when the inflows are strong, as they were in 2014 and 2015, they have been buyers of property when prices have already risen.
At this stage I’ve heard open-ended fans say: “Well, I’m a yield investor. My clients don’t appreciate me chasing performance.” The average yield of open-ended UK direct property funds at the end of November was 3.2%, versus 5.8% for their closed-ended equivalents. Taking everything into account, it is very hard to explain why there are more assets invested in open-ended UK direct property funds (£15bn) than in their closed-ended rivals (£11bn).
Interestingly, trading volumes for UK property investment companies are going up and discounts have narrowed since the open-ended fund suspensions of 2016. So the message is getting across to many investors that investment companies have a much better structure for investing in property and illiquid assets. Or to go back to the three little pigs, the house of bricks wins every time.
Let’s hope the FCA addresses the fundamental problems with open-ended funds that invest in illiquid assets. We believe open-ended funds need to offer “reliable redemption” by matching their redemption terms to market reality. That could mean investors need to give notice to access their cash, but they would know from the outset what they were signing up for. Otherwise, it’s inevitable that the big bad wolf of market sentiment will blow those funds down again and again.
Annabel Brodie-Smith is communications director at the Association of Investment Companies
