Britain’s favourite topic. Property.
But I’m not talking about the residential property that you and I live in, or the buy to let market. This update is about the current uncertainty in property investment funds, which pool investors’ money together so they can all invest in a portfolio of commercial property including industrial warehouses, office buildings and retail property.
Property can be a great diversifying asset alongside cash, equity and bonds. And commercial property funds allow small investors to gain direct access to an asset class that they wouldn’t normally be able to reach, afford, or transact in, on their own.
It’s topical right now because Brexit and a simultaneous retail downturn have caused uncertainty in commercial property market valuations. Everyone is worried about property. Consequently, short-term speculators and unadvised investors have been withdrawing their money from property funds at an increasing rate, which came to a head yesterday when one of the UK’s largest property funds, M&G Property Portfolio, suspended access to its fund.
One of the UK’s largest property funds, M&G Property Portfolio, suspended access to its fund
What does that mean? Basically, more cash is being requested for withdrawal than is available to distribute (because it’s all tied up in property) so the fund has been suspended until some of the underlying property within the fund can be sold to meet the demands. The fund will not allow any further withdrawals until such point that M&G repositions the portfolio to meet the demands.
Not good for anyone who needs their money right now.
Is this unusual? Well, it doesn’t happen very often, but many high-profile property funds also suspended access after the original Brexit referendum in 2016, with funds closed for several months.
Am I affected? Not currently. We don’t hold this fund in client portfolios and there are fund specific reasons why M&G has had to do this, but having said that it does have implications that you should be aware of.
Open-Ended vs Closed-Ended Funds
Without wishing to get too technical, you must appreciate the basic difference between an ‘open-ended’ and ‘closed-ended’ property fund. Bear with me here.
The most common property funds, such as the suspended M&G fund are open-ended. Open in so far as the number of ‘units’ available in the fund is unrestricted. If a new investor comes along then more units in the fund are created by the fund provider, and the money is used to buy more property. Likewise, when an investor leaves, their units are encashed (usually paid back from cash reserves) and a property is eventually sold, if required, to meet future demands. The total of all the units available equal the value of all the property held in the fund. The key point here is that the value of each unit is directly linked to the value of the property and sale and purchase is controlled by the fund provider.
Closed-end funds, on the other hand, have a closed and fixed number of shares, which trade on the open stock market. The fund also invests in commercial property, but as the number of shares is fixed their value is not only determined by the underlying property assets, but also by market sentiment and the general supply and demand for the shares. The share price may be influenced by factors other than property value.
Why is that important to understand? One word. Liquidity.
Liquidity
Liquidity is the ability to quickly buy or sell an asset in the market at a price reflecting its value.
Liquidity is the ability to quickly buy or sell an asset in the market at a price reflecting its value
Property is inherently illiquid (hard to sell quickly). If you invest in property you must appreciate this.
In an open-ended fund, cash reserves generally meet a normal amount of withdrawal requests plus contingency. But when excessive withdrawal requests are made at the same time, there is a real risk that the fund provider will be unable to meet all of the withdrawals from cash until properties are sold. Open-ended property funds are therefore illiquid at times of market stress. i.e. You might not get your money back immediately.
In comparison, closed-ended funds offer greater liquidity and access. This is because shares in the fund (not provider units) are tradable and can easily be sold on the stock market at any time. Trading the shares is not dependent on provider cash reserves or property sales.
Which is better?
Most of our clients invest via open-ended funds.
Open-ended funds do suffer from occasional short-term illiquidity as we’ve seen with M&G this week. But if you’re a well-diversified, long-term investor without the need for short term capital or regular withdrawals such as a retirement income, then the short-term illiquidity in these funds should not cause you to panic. Ongoing valuations are based on the value of the underlying properties within the fund, so you are unlikely to see wild swings in value, making it simpler to understand. We don’t recommend any more than 10% of your overall investment portfolio is held within a property fund so liquidity via other assets should still be high.
Closed-ended property funds do offer greater liquidity, especially to those who need short-term access or the funding of regular withdrawals from capital e.g. Retirement income. However, because share prices can be influenced by factors other than the property valuation, the daily share price may not truly reflect the value of the property held within the portfolio.
An extreme example of this is during the financial crisis when the average open-ended property fund temporarily lost 23% of its property value, compared to a temporary loss of almost 75% on a popular closed-ended fund with the loss compounded by general negative sentiment and low demand for shares.
If you’re growing wealth then an open-ended fund may offer a smoother ride at the expense of liquidity, and if you’re taking withdrawals then a closed-ended fund may offer greater liquidity at the expense of a more volatile ride.
In Summary
The commercial property market is uncertain right now and you should be prepared for further open-ended property fund suspensions as the M&G suspension may cause short-term speculators to increasingly request withdrawals from other funds.
Every one of our clients is advised to hold an emergency cash reserve and diversify their investments to meet their risk profile so that short-term factors do not negatively influence long-term plans. The general election and subsequent Brexit plan may resolve the uncertainty, however, if you do have any concerns please get in touch with me so that we can talk about your own situation.
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