Though the M&G Property Portfolio has been suspended, in an update on selling down properties to meet redemptions its managers reassured investors it wasn’t sitting in ‘idle’ cash. M&G’s rivals in the Investment Association UK Direct Property sector have up to a quarter of their portfolios in cash, and yet mostly charge their investors a full management fee.
The M&G Property Portfolio has the smallest allocation, at 4.8%, according to its December factsheet, but has anticipated this reaching 16% once the portfolio has sold properties to raise cash. Though Fairview Investing consultant Ben Yearsley believes M&G took the wrong decision on cash, he is “more supportive of their actions over the last year than many others”. “They were trying to run an open-ended property fund as fully invested as they could be,” he says.
Shore Financial Planning ditched open-ended funds entirely last year, having previously favoured the L&G UK Property and Janus Henderson UK Property funds, which hold 23% and 15.7%, respectively, in cash, says Yearsley. “It didn’t feel comfortable for many reasons, liquidity and cash being the main ones.” He now prefers BMO Property Growth & Income, which has 30% allocated to direct property and 70% in Reits, and Schroders Global Cities, which only holds Reits. The funds have 4.8% and 2.1%, respectively, in cash, according to Trustnet.
FCA worried about cash drag as it mulled liquidity mismatch in funds
Yearsley isn’t alone in his disapproval of high cash buffers. The Financial Conduct Authority considered issuing guidance on minimising cash levels in property funds as part of its rules on illiquid assets in open-ended funds. “Large cash positions create a drag on yield, diminishing the fund’s performance and potentially disappointing investors who expected to be more fully exposed to the risks and rewards associated with a particular asset class,” it said in a policy paper. The FCA backed down when it issued its final rules in September 2019.
That cash drag could be even higher today with UK interest rates at just 0.75%, according to M&G CIO Jack Daniels. “Historically, we have held a low cash buffer in the conviction that our customers pay us to invest their money, not to keep it idle – particularly in times of near-zero cash interest rates,” he says. But the M&G fund ranks bottom of the sector over three years on a total return basis, delivering 2.5%, according to FE Fundinfo.
In contrast, the L&G UK Property Fund has the largest allocation to cash, with an additional 2% in Reits. That has not put off investors: it is the largest fund in the sector, with £3bn assets under management, according to Morningstar. It also has some of the best performance on a total return basis, delivering 17.5% over three years, according to FE Fundinfo.
Tilney head of multi-asset funds Ben Seager-Scott describes higher cash levels in the sector as “a necessary evil”.
Tilney has been investing in L&G UK Property, alongside the Janus Henderson UK Property and Standard Life UK Real Estate funds, for more than a decade. Seager-Scott says he would only tinker with the allocation if there was “a material change in the funds or asset class”. He says investment trusts work for private client portfolios where tactical allocations can be made in response to discount/premia dynamics.
Premiums in the Investment Trust Property – UK Commercial sector range from 16% on the Supermarket Income Reit to a 20.6% discount on the AEW UK Long Lease Reit. Only the UK Commercial Property Reit has a discount control mechanism that kicks in when the discount hits 5% although 21 have policies around managing the discount or premium.
Why has cash-heavy L&G UK Property outperformed?
L&G UK Property manager Matt Jarvis says the team is comfortable with its cash levels “given the current market”, although its long-term objective is to hold 15%. “With 23% in cash, we can continue to manage our portfolio efficiently, as we diversify the holdings into more operational and alternative property assets, such as build-to-rent residential, hotels, student accommodation and self-storage.”
Square Mile investment research analyst Daniel Pereira says pricing policy and property valuation write-downs have hit performance of some LGIM rivals in the IA UK Direct Property sector.
L&G UK Property, Janus Henderson UK Property and Threadneedle UK Property all have a fixed bid-offer spread, while most others have swing pricing that shifts performance when it changes. BMO UK Property jumped 4.6%, for example, when it adopted offer pricing in February.
Pereira says: “L&G UK Property has been less exposed to these two occurrences, as it has historically applied a fair value adjustment, rather than swing its price.
“In addition, low exposure to the retail sector has helped, as has its high cash weight, meaning it fell by less than other funds in the sector during periods of heightened volatility in the asset class.” M&G Property Portfolio had a 40% allocation to retail at the time it was suspended, double the amount of L&G UK Property, according to FE Fundinfo.
According to AJ Bell head of active portfolios, Ryan Hughes, the cash drag may be more notable in the yield on L&G UK Property, which at 2.9% is among the lowest in the sector, according to FE Fundinfo. “M&G is near the top for yield because it is running lower cash and its properties are yielding more than the cash. However, it is near the bottom for total return because performance of the properties is bad compared to cash.” The M&G Property Portfolio has a yield of 4.2% and a historical yield of 3.5%.
Most asset managers shy about why they charge full fees on cash-heavy portfolios
LGIM did not respond to requests for comment about whether its management fee should be adjusted in line with its high cash levels. The BMO UK Property fund, by contrast, which has a 0.75% management charge, has rebated fees on cash levels over 15% since August 2018. Its ongoing charges figure was 0.83%, according to its January factsheet.
Hawksmoor senior fund manager Ben Conway says: “If the AMC is 0.75% and cash level is 20%, then in effect the investor is being charged 0.9375% by the manager for giving the investor exposure to physical property. It is up to each individual investor to decide if this represents good value or not.” Hawksmoor only invests in investment trusts for property exposure.
The majority of Investment Trust UK Commercial Property sector constituents charge fees on net assets, although fees will inflate alongside gearing in the handful that charge on gross assets.
Janus Henderson and Columbia Threadneedle did not respond to questions about whether management fees should be adjusted in line with cash levels.
A Kames spokesperson said it was clear from the outset the Property Income mandate was for 80% holdings in real estate and 20% in cash and liquid assets with fees set to reflect this. The Kames fund has an OCF of 0.83%, according to its January factsheet.
Aviva Investors, which has an OCF of 0.74%, defends charging a full fee on a portfolio that at the end of January 2019 held 21.2% in cash, stating liquidity management is a fundamental part of the fund manager’s role. A spokesperson says: “A significant part of the work of the fund manager goes into considering the relative liquidity of assets in the prevailing market conditions and managing the balance between the properties, cash and other liquid assets within the fund appropriately.”
Brexit highlights problems with low cash buffers
The Brexit referendum highlighted the penalty open-ended, daily dealing property funds that run lower cash buffers can face when sentiment turns.
Willis Tower Watson head of real assets Paul Jayasingha notes some opportunistic property funds available to its institutional clients were buying up properties from funds for retail investors that had been forced sellers. For example, Brockton Capital scooped a property from Aberdeen Standard Investments for a reported £85m in July 2016, only to flip it four months later for £103.5m.
Segregated mandates are not an option open to many, but Jupiter Merlin used this route to make its first allocation to property in 2014. The Mayfair Capital Commercial Property Trust represents less than 5% in both the Income and Balanced portfolios, says fund manager Amanda Sillars. “Having no investors beyond the two Jupiter Merlin portfolios, the trust can be fully invested,” says Sillars, noting no cash is needed to cover redemptions.
“This means the income stream from the underlying properties is not diminished by holding cash or listed equities.”
Do investment trusts make life easier for property fund managers?
In the closed-ended sector, Standard Life Investments Property Investment Trust manager Jason Baggaley enjoys the flexibility that comes with managing purchases via gearing.
“With the revolving credit facility we have the ability that if we see an asset, which we think provides great opportunity, we can buy it by drawing down some debt.” The trust will then either run with higher gearing for a period of time, issue further shares, albeit at a premium to avoid dilutive effects on existing shareholders, or sell another property within the portfolio. Gearing on the £495m investment trust is currently 32%.
While UK interest rates compound the cash drag in open-ended funds, the other side of the coin is that the SLI Property Investment trust is borrowing at a rate of 2.7% while delivering a yield of 6%.
Baggaley says he has “undoubtedly” seen a lot more interest in investment trusts, noting some clients have made a full transition to closed-ended funds while others balance their allocation between both structures.
In the period since July 2016, the month after the Brexit referendum, UK property investment companies have raised £1.6bn, mostly through £1.3bn worth of secondary fundraising. In contrast, the six largest constituents of the IA UK Direct Property sector have faced net outflows of £8.2bn over the same period, according to Morningstar data.
He acknowledges, however, that larger investors may struggle with the liquidity of a closed-ended vehicle and the effect they may have on share price. “They both have advantages and disadvantages. And for most investors probably having a mix is their best their best solution.”
