Uncertain future for UK property funds as LTAF rule change looms

Fund groups are insistent daily dealing property funds have a place in the market, as the suspension of the Janus Henderson UK Property Paif and the Financial Conduct Authority’s liquidity review cast a shadow over the sector.

UK property funds have been through the wringer, with sudden market downturns from the Brexit vote and coronavirus pandemic triggering a raft of suspensions, followed by a wave of redemptions.

Against this backdrop, the number of funds has dwindled, with Aegon and Aviva Investors liquidating their strategies last year and Abrdn merging its two property and feeder funds.

Now the Janus Henderson UK Property Paif has been added to the list of dropouts, with the asset manager suspending the vehicle and its feeder fund ahead of a sale of the assets to a single buyer later this month/in early April.

Janus Henderson’s decision was motivated by incoming regulatory changes, with the FCA pushing the long-term asset fund (LTAF), a new open-ended structure with 90-180 day mandatory notice periods, as a solution to property funds’ liquidity mismatch problem.

Quilter Cheviot property research analyst Oli Creasey says, while the Janus Henderson suspension “looks like being a one-off,” the longer the LTAF rules remain uncertain, the more likely it is “funds will consider their future”; which, for some, could involve winding up.

“The [Janus Henderson] suspension was originally sparked by news breaking about this fund in particular, not the sector, so in the short-term we don’t think investors in other funds will rush for the exit in the same way.

“That being said, it is partly the operating environment that caused the Janus Henderson fund to pursue a sale in the first place, and we’d be surprised if one or more other funds hadn’t at least considered doing something similar.”

Everyday investors are not used to monthly liquidity

Fairview Investing founder and director Ben Yearsley believes the UK direct property sector’s days are numbered.

Should the LTAF proposals come to pass, Yearsley says it’s fair to assume daily dealing property funds will have to adhere to the same rules and adopt a minimum 90-day notice period. This would make them unfeasible for most D2C platforms, which do not have the capabilities to offer non-daily dealing funds.

“I think more funds will close because investment platforms and everyday investors aren’t used to having monthly liquidity.

“The reality is you don’t need daily liquidity. It’s just gotten to this point where it’s expected, and nobody’s built the functionality to be able to cope in any other way.”

See also: Majority of retail investors would ditch property funds if FCA implements notice periods

UK property managers remain committed to daily-dealing structure

Despite an uncertain outlook, major UK property fund providers told Portfolio Adviser they remain committed to the daily-dealing structure and are well-equipped should investor sentiment sour.

Legal & General Investment Management’s UK Property fund, the largest in the sector with £2.4bn in assets, currently has around 17.4% in cash.

“Fund size and liquidity were stable throughout 2021 and the funds are well placed for future performance with overweights to the Industrial and Alternative sectors and an underweight to Retail,” says Mike Barrie, director of fund management for LGIM Real Assets.

“We continue to review all existing and potential product offerings and the regulatory landscape to ensure they remain fit for purpose and meet existing and future investor demand for continued access to the UK property market and LGIM’s award winning property fund management expertise.”

UK direct property fund cash levels

Source: Factsheets as at 31 January 2022

Abrdn says the £1.6bn merger of the Aberdeen Property fund into the SLI UK Real Estate fund has “simplified and enhanced our offering for investors by creating a UK direct property fund of significant scale that is diversified by sector, asset type and income stream/tenancy”.

“Whilst the FCA’s consultation on the open-ended, daily traded, property funds sector is still ongoing, we are committed to our offering in this space,” SLI UK Real Estate manager George Shaw stresses.

“Direct real estate funds offer much needed diversification benefits to investors when held as part of a multi-asset portfolio, and this has been particularly evident over the recent past. We, therefore, intend on addressing any outcomes from the FCA’s consultation in a collaborative manner through engagement with our existing investor base such that they can continue to benefit from an allocation to the sector in the future.”

Inflation hedge

Managers were also keen to highlight the asset class’s inflationary benefits, adding this could draw investors back into the sector.

“Against current UK economic headwinds of rising and persistent inflation, rising interest and finance rates, and an increasing tax burden, the UK property market is moving along nicely continuing to produce month-on-month rental and capital growth in response to GDP growth forecasts that is bolstering occupational demand, and the weight of money wanting to access property,” says Michael White, head of UK property at Canada Life Asset Management.

“We see this continuing through 2022 unless geopolitical tensions, the economic cost of sanctions against Russia and an increased threat of a war in Europe come to bear.”

BMO UK Property manager Guy Glover echoes this sentiment, stating the fund is “positioned to capture the renewed significant investor interest in UK commercial property, driven by investors seeking alternatives to fixed income, and those seeking to benefit from the inflationary protection that real assets provide”.

But Creasey says he is “somewhat cautious” on this viewpoint. “Inflation and property returns are correlated, but property is more influenced by other economic factors, and so will not always protect against inflation. 2007-09 was a good example of this, when property values fell sharply and showed no clear link with inflation.”

Yearsley adds that while inflation is typically good for real assets like property, rising interest rates are not.

Hybrid funds are the way forward

Yearsley thinks hybrid funds, which invest in a combination of direct property and listed real estate securities, are the way forward for the sector.

The £481.5m BMO Property Growth & Income fund currently operates a hybrid model, with roughly two thirds of the portfolio invested in continental and UK property shares and the other third in physical properties.

Last September, Time Investments also launched a hybrid vehicle, marking one of the first new property fund launches in years.

Yearsley says he is surprised Janus Henderson didn’t convert its UK Property Paif into a hybrid fund since they already have funds that invests in property shares, including the Horizon Global Property Equities Sicav.