Investors shouldn’t need the regulator to step in and protect them from the liquidity constraints of open-ended property funds, according to Richard Shepherd-Cross (pictured) of the Custodian REIT, who says they simply need the right structure to access this sector in the first place
.
The Financial Conduct Authority (FCA) launched a consultation on using open-ended funds to access illiquid assets earlier this month. This came after numerous property funds in the Investment Association universe were forced to suspend trading in the aftermath of the UK’s vote to leave the EU, when investors rushed to pull money out at the same time.
Shepherd-Cross said this scenario is likely to be repeated.
“The fundamentals haven’t changed around that open-ended space so if you invest in one of those vehicles, there is every chance that if there is market volatility you will not get your money, they will gate again,” he explained.
“They might argue there is no liquidity. Or they might say they will keep liquidity back, but that in itself is a negative as that liquidity they are holding should be invested in the real estate to generate those returns.”
Among the proposals the FCA is consulting on are plans to suspend trading earlier than before if recommended by an independent valuer, producing contingency plans, and disclosing more information on liquidity risks.
It is hoped these measures will help retail investors better understand any restrictions on access to their funds and prevent further mass redemptions which have the potential to destabilise the market.
However, Shepherd-Cross said that while these funds managed to convince everyone that by suspending trading they are doing the right thing to protect investors, “investors shouldn’t need protection from a flawed structure – they should just have the right structure”.
“What makes me vexed is that if you are an institutional investor and you want to invest in an open-ended structure, you’re wrong, but it’s your choice and you’ve got a research team and you are big enough and ugly enough to sort yourself out,” the manager continued.
“The problem I have is that retail investors are being told that if you want exposure to property, you can buy an open-ended fund because they are liquid. They are not. They have proved themselves time and again when you really need liquidity they are not liquid.”
Shepherd-Cross said the reason open-ended funds are not liquid is because they have separated liquidity and price.
As an example, he said that the value of shares and the underlying physical assets in an open-ended direct property fund will stay at exactly the same level even if demand for the shares rockets, which doesn’t make sense. In a closed-ended fund on the other hand, the share price will rise if demand increases, meaning existing shareholders are only affected in a positive way as new investors will buy in at a premium.
The manager added that if investors stopped to think about what exactly it is they are investing in, it should be obvious.
“Often when I have a discussion with investors about liquidity, they say ‘I know you are buying an equity when you buy Custodian REIT”. But you are not really,” he said.
“You are buying property. If you bought property, you wouldn’t demand five-minute liquidity on it. And you wouldn’t wait until the market took a dive and think 'I’ve got to get out'. You would do the complete reverse. But just because it’s an equity, people seem to forget what they have invested in.
“If property performs over the long term it’s not headline news. Property produces long-term stable cashflows: government-backed or retail warehouse-backed – it is beautifully-backed and it produces long-term stable cashflows.
“If you align your investment policy with what property does well, you’ll be very happy with it. If you try to make short term gains and get out when the market falls, you are only going to create hell for yourself. Which is exactly what is going on.”
Despite the liquidity advantages of closed-ended funds for accessing property, many investors remain sceptical of the asset class in the UK while Brexit-related uncertainty continues to rumble on.
However, Shepherd-Cross said this is having much less of an impact than had been predicted and while the sector took a hit in the three months after the vote to leave the EU, it has pushed on since then.
He added that while there is no question that the uncertainty of the outcome of Brexit negotiations is creating some disquiet, the day-to-day pressures of a normal property cycle are still having a much greater impact on the market.
“We do not believe that anyone is forecasting a wide-scale collapse of businesses leading to tenant default post-Brexit, so income returns from property should be robust,” he added.
“A more realistic and measured forecast is that domestic demand from occupiers for regional property will be broadly consistent pre- and post-Brexit and the current pressures on rents from demand, development costs and supply will also remain.
“In London we have witnessed a continued demand for investment property from overseas investors which bodes well for the post-Brexit market.”
He concluded: “If we experience volatility post-Brexit we believe that investors may be better served being invested in a well-diversified, UK regional property portfolio with a focus on dividend income investments that are more closely linked to the wider financial market.”
Data from FE Analytics shows the Custodian REIT has made a 47.1 per cent total return since launch in March 2014 compared with 44.65 per cent from the IT Property Direct sector.
Performance of trust vs sector since launch
Source: FE Analytics
The trust is on a premium of 13.96 per cent compared with 11.79 and 8.94 per cent from its one- and three-year averages.
It is 21 per cent geared, has ongoing charges of 1.37 per cent and is yielding 5.43 per cent.