It's rare that investment funds make the news headlines yet this week they managed to but for all the wrong reasons. At the time of writing 8 commercial property funds had either stopped investors withdrawing funds altogether (called a fund closure) or written down the value of the assets within their funds by such an extent to hopefully deter investors from withdrawing their money. So what is going on? Why is this happening and will it hit your returns? I answer these questions below as well as expand on my comments which the Sunday Times requested earlier this week.
What is going on with property funds?
At the start of June I highlighted in one of my weekly notes the risks facing investors in commercial property funds ahead of the impending EU referendum. So convinced were the industry that we would remain in the EU that any such concerns were dismissed by the investment houses running commercial property funds. No surprise there. However, as you know I removed any commercial property exposure from my £50,000 portfolio back in May.
Ahead of the referendum commercial property funds started experiencing significant outflows as investors became jittery over the prospects for the asset class. Remember that commercial property funds mostly invest in things like office blocks, shopping centres and factory units. The warnings were there that a Brexit from the EU would send the UK economy into recession. It was just that most voters chose to ignore these warnings. The knock on effect was always likely to be that companies would reduce capital expenditure, potentially relocate back into the European Union or renege on their property rental agreements as bushiness conditions became more difficult. All of these are bad news for commercial property funds. Unsurprisingly a number of funds started to widen their bid/offer spreads which effectively applied a 5% penalty to anyone trying to take their money out of the fund.
When the UK electorate actually voted to leave the European Union the rate of withdrawals from commercial property funds accelerated. As you may know there are broadly three types of fund structure, namely unit trusts, investment trusts and exchange traded funds (ETFs).
The unit trusts are opened-ended which means that the fund manager can create or remove units (or shares) in the fund to meet demand. The price of these units is based upon the underlying value of the assets the fund holds. Investment trusts are closed-ended which means that the number of shares available never changes and so their price is influenced by supply and demand. They operate much in the same way as ETFs.
Of course commercial property is illiquid in nature. You can't just sell part of an office block to give investors wanting to leave the fund their money back. Even if you were to sell an entire office block a) it is not easy or quick to do and b) you'd have to sell it at a huge discount to attract a buyer quickly. When commercial property is held within a unit trust structure the fund manager is compelled to help investors redeem their money because the fund's units are not openly traded in the market place as investment trusts or ETFs are. In times of intense market stress that means that the fund manager has two choices:
a) try and sell assets at depressed levels and give those leaving the fund their money, which at the same time penalises those who stay in the fund
b) stop investors withdrawing the money at all or make it so unattractive to do so that they won't
Well a number of the biggest unit trust property funds have opted for the latter course of action as they can't meet the scale of withdrawals.
Which property funds have stopped investors withdrawing their money?
The table below summarises the situation at the time of writing:
| Fund | Action | Fund size |
| Henderson UK Property PAIF (and feeder funds) | Withdrawals suspended & cut fund value by 4% | £3.9 billion |
| Columbia Threadneedle UK Property Fund | Withdrawals suspended | £4.4 billion |
| Canlife Property & Canlife UK Property | Withdrawals suspended | £450 million |
| Aberdeen UK Property Trust | Withdrawals suspended & cut fund value by 3.75% | £3.4 billion |
| M&G Propert Portfolio | Withdrawals suspended | £4.3 billion |
| Aviva Investors Property Trust | Withdrawals suspended | £1.8 billion |
| Standard Life UK Real Estate | Withdrawals suspended & cut fund value by 5% | £2.9 billion |
| Legal & General | Cut value of fund by 15% | £2.3 billion |
All of the above are open-ended funds (i.e. unit trust or OEICs). In normal market conditions holding illiquid investments via a unit trust is not usually a problem. However, in times of acute market stress it means that funds have to close in order to prevent a fire sale. Investment trusts on the other hand are not forced to sell assets as their share price simply falls in response to supply and demand when they are traded in the open market.
At the moment nearly half of all the money investors have in commercial property funds is now locked in. This situation is even worse than in the aftermath of the financial crisis! Yet the newspapers are full of advisers claiming that funds are overreacting and market conditions are nothing like 2008. Yet bear in mind that these advisers have got lots of clients now on the phone asking why they can't get their money out of these falling property funds. So of course the advisers are going to blame someone else, despite the fact that they recommended them, and claim fund managers are being overly cautious. The truth is that fund managers are halting withdrawals to stop a vicious circle of selling and not to be vindictive.
What about the property funds in July's 80-20 Investor Best of the Best Selection
There are two funds in this month's Best of the Best Selection which have not been affected by any kind of closure. In fact the chart below shows how much money they've made in the first few days of the month. That is precisely because they are globally diversified, investing in equities rather than actual buildings and have very little exposure to the UK. So the chaos surrounding UK property funds is not directly affecting 80-20 Investors at all. Click to enlarge.
The 80-20 Investor algorithm will always automatically screen out funds which close so none of the property funds that have closed will appear in our shortlists. However, I will be reviewing whether to temporarily remove the property sector from the unit trust section of 80-20 Investor.
My comments for The Sunday Times
What to do and when will fund suspensions be removed?
The Sunday Times contacted me earlier this week for my view on how property funds would bear up in the coming months and whether any would likely fare better than others. For example would funds having much bigger exposures to regions outside of London and the South East than is typical fare better? Below is my response. Bear in mind that at the time of writing only Standard Life and M&G had taken any action by that point.
My response:
This latest development was always in the pipeline. In the months ahead of the referendum commercial property funds came under pressure as foreign investors became spooked by a potential Brexit scenario. As such many commercial property funds adjusted their pricing, effectively hitting anyone trying to sell out of their funds with a 5% charge. The aim was to slow redemptions being made by investors. Talking to investment houses at the time, the view was that we would remain in the EU which would spark an influx of money into property funds causing a short term rally with most of the redemption penalties disappearing across the industry. Of course they were wrong and shows the folly in trying to predict the property market. It also demonstrates how sensitive it is to macro events.
That's why I moved out of commercial property with 80-20 Investor in May because the prospect for commercial property had already deteriorated, and that was before you even took into account the Brexit potential.
Commercial property is going to struggle in the coming months and no fund will be immune. We will see a wave of fund closures as redemptions continue [edit: AFTER I WROTE THIS THERE WERE A FURTHER FIVE FUND CLOSURES INCLUDING THREADNEEDLE WHICH DELIBERATELY HOLDS LESS LONDON & SOUTH EAST PROPERTY THAN MOST FUNDS]. The liquidity measures of most UK property funds range from 2% up to 20%. Funds with signifiant cash buffers such as the Legal & General UK Property (which has 20% in liquid assets, mostly cash) should theoretically weather the storm better than most but don't bet on it [edit: AFTER THIS COMMENT LEGAL & GENERAL APPLIED A 15% FUND DEVALUATION ALTHOUGH THE FUND REMAINS OPEN]
Those investors caught by a property fund closure may wonder when will it be removed? If we go back to the financial crisis when we last saw property fund closures, the funds often reopened around a year later. What this episode once again demonstrates is the unsuitability of an OEIC structure for holding illiquid assets such as commercial property in times of market stress.
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