The “writing has been on the wall” for some time for open-ended property funds, according to several industry commentators, following the recent closure announcements by M&G and Canada Life.
Following M&G’s decision to suspend its £565m Property Portfolio with an intention to shutter the portfolio, there are now 12 constituents in the IA UK Direct Property sector, the largest being the £1.4bn Legal & General UK Property fund.
The M&G closure followed a similar announcement from Canada Life, which confirmed its intention to shutter its own open-ended UK property fund last week.
Canada Life’s decision came due to a raft of redemptions which resulted in WS Canlife UK Property ACS assets dwindling to £102m from £254m, leaving it ‘no longer commercially viable’.
Over the last five years, the average IA UK Direct Property sector fund was down 0.2% in total return terms. Over the same period, the M&G Property Portfolio returned a negative 20.1%, according to FE Fundinfo data.
According to industry commentators, the sector as a whole has struggled with liquidity mismatch issues in recent times, with funds having to balance liquidity requirements for daily dealing while investing in a highly illiquid asset class.
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“While it is unexpected, it isn’t a massive surprise to see the M&G fund call time and begin liquidating,” said Oli Creasey, equity research analyst at Quilter Cheviot. “In the past we’ve argued that a fund below £1bn in assets under management may struggle to be sustainable, as the lack of scale makes it hard to put together a diversified portfolio of property assets.
“And while the fund does not appear to have had liquidity issues this time around – it held 19% in cash and a further 6% in relatively liquid equities as of 31 August – the fund has struggled in the past, suspending in December 2019. This combined with a general lack of interest in the sector from investors, plus the overhanging threat of FCA regulation, has driven management to throw in the towel.”
He added: “It’s a shame to see another long-standing property fund exit the sector, but it may not be the last. Only a handful of funds remain, and while they tend to be the biggest/best, even they have seen shrinking AUM as property values fell in the second half of 2022, and net redemptions reduced portfolio sizes further.
“It’s also worth noting that while the M&G fund expects the liquidation process to take around 18 months, lower than average property transaction volumes may make this difficult to achieve. We note that while the Janus Henderson fund successfully liquidated in short order in 2022, with a single buyer taking the entire portfolio, others have not been so lucky.
“Aegon suspended in March 2020, and has been liquidating a relatively small portfolio since summer 2021, a process that is still ongoing. Will the last one out of daily-dealt property funds, please turn off the lights?”
‘Writing on the wall‘
Ryan Hughes, head of investment partnerships at AJ Bell, believes the decline of the sector has been coming for a sustained period of time.
He said: “The writing has been on the wall for open-ended property funds ever since they suspended again in the depths of the Covid crisis. That triggered funds in the sector to begin closing down given the evident problems with liquidity that resulted in a fundamental mismatch in the demands of investors against the liquidity of the underlying assets.
“Offering a daily dealing structure for an asset that can take months to sell was an accident that happened all too often and one that ultimately undermined investor confidence.
“The FCA looked to address the issue through tentative proposals to limit access but while this was a potential solution, the likelihood was always that retail investors would want the comfort blanket of daily dealing even if they didn’t need to access the asset.”
“The suspension of the M&G Property Portfolio fund is not a surprise given the uncertainty hanging over open-ended funds ever since the FCA announced its review, with assets coming out of the sector as investors looked to get ahead of any further announcements,” Hughes added.
“The fund is widely owned by retail investors and they will now enter a frustrating period of having to wait for the assets to be sold.”
Daily dealing misconception
However, the Association of Real Estate Funds (AREF) managing director Paul Richards said there is a misconception that retail investors require daily dealing for property funds.
“The wave of open-ended property fund suspensions seen during the Covid crisis was not due to any liquidity issue,” he said.
“The problem was one of ‘material uncertainty’ clauses being invoked by the independent valuers. With those clauses, the managers could not price the funds with confidence and were compelled to suspend trading in them.
“There is a misconception that it is the retail investor that requires daily dealing for these funds. Generally speaking, consumers display little interest in the issue. Rather, it is their advisers and wealth managers, whose processes struggle to cope with anything other than liquid assets. The same can be said for investment platforms, whose systems and processes preclude less liquid property funds.”
“Regulation is yet to help the sector by coming up with the tools to improve liquidity management, changes that would allow these funds to have longer notice periods for redemptions, addressing the liquidity mismatch issue. It is to be hoped future regulation will be more benign.
“The sector once had over £20bn invested in it and was growing nicely. The obsession with daily dealing is profoundly unhelpful and narrows the opportunities for investment portfolios of retail investors and pension savers and reduces the capital available for levelling up and developing suitable housing.”
