The reopening of the BMO Property Growth & Income fund before its peers has raised questions about why more property funds do not employ hybrid portfolio models that combine physical and listed property.
The fund, managed by Marcus Phayre-Mudge (pictured) and George Gay, suspended on 18 March alongside a raft of property portfolios that had been hit by valuation uncertainty due to the Covid-19 lockdown.
But this week, the fund became the first in the Investment Association universe to reopen thanks to the fact only 30% of its portfolio is in physical property. Its independent valuers, Knight Frank, have lifted the material valuation uncertainty on its industrial holdings, although the fund’s allocation to offices is still affected.
In the three months since its suspension, the fund, which sits in the IA Property Other sector, has returned 18.9% compared to a -3.1% fall in the IA UK Direct Property sector, where funds with at least 70% in physical UK property sit.
See also: UK property funds could reopen over summer as valuation uncertainty lifts in some sectors
Could asset managers finally turn their attention to hybrid property funds?
Fund manager Phayre-Mudge reckons yet another bout of suspensions could prompt more asset managers to consider a hybrid model for property funds.
“Going back to the launch of the product in 2005, it was very much designed to give investors, an alternative to these open-ended daily dealing physical funds, which I felt added a liquidity mismatch. Of course, I was just a little bit early with that, obviously we saw gatings in 2008 and again in 2016.”
Square Mile senior investment consultant Jake Moeller agrees that property fund suspensions will prompt product change.
“All asset classes evolve and adapt and the current environment is expediting evolution, rather than extinction, for commercial property – hybrid funds will be a part of that.”
Fairview Investing consultant Ben Yearsley does not foresee asset managers launching property funds in the near term due to problems currently plaguing the asset class, but says it could be possible that they adapt existing mandates to a hybrid.
Yearsley reckons part of the reason asset managers didn’t take that approach in the past is due to the different skill sets required to analyse physical property compared to listed securities.
He also points to demand from investors. “I was one of those people that thought property shares weren’t real property because of diversification and all that nonsense. But if you’re a long-term investor I don’t think it matters. I’ve changed my mind on this in the last two or three years.”
In September 2019, Shore Financial Planning, where Yearsley is a director, switched into the BMO Property Growth & Income fund, having previously held direct property funds.
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The strength of correlation between property securities and direct property
Moeller says investors should be aware of the different characteristics hybrid funds will impart on a portfolio.
“The shorter-term correlation property securities have to equities needs to be accounted for during portfolio construction,” he says.
“Furthermore, property securities are more liquid but investors then have the dilemma of crystallising a loss if the shares trade at a large discount to NAV. At least a suspension of a direct property vehicle allows for an orderly disposal of an asset at fair value.”
But Phayre-Mudge points to correlation figures for property over different periods.
“If your hold period is more than 12 months, they behave more like real estate and less like the broader equity market because they are effectively another form of the same.”
While over a three-month period, the correlation coefficient between the FTSE EPRA Nareit UK and MSCI UK Property Index is 0.51, it hits 0.73 at one year and reaches 0.87 over a decade. Phayre-Mudge says most investors will be holding property as a long-term investment.
He argues there are other benefits to property securities beyond liquidity, pointing to his ability to access specialist areas within healthcare, German residential, supermarkets and industrials.
“If you want to go buy that as a physical portfolio it would be impossible, because you’d need to have a huge fund with enormous technical expertise, to deal with care homes, blocks of German residential flats and supermarkets and logistics across Europe, whereas the equity market offers you that smorgasbord.”
Geographic diversification is another benefit, he says, arguing there are lots of attractive markets in Europe that constituents of the IA UK Direct Property sector may miss out on.
See also: REITs face same uncertainty that prompted raft of property funds suspensions
‘I’m not sure a halfway house is what most investors really look for in this space’
Hawksmoor Investment Management employs the BMO Property Growth & Income fund across its private client portfolios and picks individual Reits for its fund of funds.
“That 30% in physical is going to you give you a good, direct property, low volatility performance and that’s going to dampen the overall volatility of your portfolio,” says head of fund management Ben Conway.
“It’s a good compromise from either doing 100% in property securities or going 100% direct, which for our business just doesn’t work.”
But Tilney head of multi-asset Ben Seager-Scott prefers to allocate to the different fund types separately, rather than within one vehicle, to control exposure.
“I think the recent trading suspensions have reinforced the illiquid nature of property as an asset class, and investors should either embrace that fact and treat it as a strategic asset that they would be comfortable if it couldn’t be traded for a period of time, or they should opt for the more liquid parts of the market,” Seager-Scott says.
“A hybrid might be attractive to some people, but by and large I’m not sure a halfway house is what most investors really look for in this space.”
He also mentions the BMO fund was forced to close while its peers in the IA Property Other sector that are 100% invested in property securities remained open.
Conway thinks the fund was unlucky to get caught up in the latest round of suspensions. “It was basically the only event possible that was going to see that fund close; material uncertainty across the entire sector is a once in a 100-year event.”
Phayre-Mudge says the fund had no liquidity problems and was “quite happily matching subscriptions and redemptions”. “The good news is Property Growth & Income has never closed to redemptions. It hasn’t closed at any point during the global financial crisis or around the Brexit referendum.”
See also: DFM property allocations run from underweight to highest ever levels
