By Paul Henson, London Head of Real Estate Disputes at Irwin Mitchell

What do 2008, 2016 and 2019 have in common? They are all years when the “gates” have closed on real estate open-ended funds. 

On 4 December 2019*, the M&G Property Portfolio fund once again prevented further redemptions in order to allow its fund managers the time to sell assets and release the cash needed to repay investors. M&G argues this is in the interests of all investors because it will have time to sell bricks and mortar assets at an acceptable price.  

Investors, spooked by the woes on the High Street and ongoing concerns over Brexit, have been withdrawing their money at a significant rate. Morningstar has estimated that £1.5 billion has been withdrawn from M&G’s fund alone since the start of 2019 and around £3.7 billion from UK property funds generally. 

In an open-ended fund, investors buy and sell shares back to the fund depending on the net asset value at the time (and not to third party investors). Funds will allocate a proportion of their funds under management to cash holdings so they can account for usual outflows. However, as result of the loss of confidence in the sector redemptions from large UK property funds had meant cash holdings have been reported to be affected as follows:  

1. M&G had only 5% cash at the end of October 2019 (down from 17.5% in May 2019)
2. Threadneedle UK Property Fund had reduced from 11.8% in June 2019 to 6.7% in September
3. Janus Henderson UK Property PAIF had reduced cash in its fund from 24.6% in June to 16.7% in October 2019
4. Aberdeen UK Property Fund cash had reduced from 18% to 11.5% in that same June to October 2019 period.

That said, Aviva Investors UK Property Fund increased cash in its fund (from 17.4% to 30%) since June 2019 by selling significant assets and reducing the overall size of the fund. 

Investors in M&G may ask why such a low figure was allocated to cash when these issues have been faced in the recent past. No doubt the fast pace of recent redemptions was one reason but M&G would no doubt also argue that holding cash does not make money for the fund (which is what investors are ultimately paying them for). However, the contrast with Aviva’s fund will no doubt be highlighted when performance is reviewed by investors.

The problem for fund managers when sentiment moves against real estate as an investment class is that they have to sell illiquid assets to meet cash demands whilst also avoiding “fire sale” prices of those same assets which disadvantage the remaining investors in the fund. Most properties of significant lot size (which these funds invest in) will take 3 to 6 months to sell and so investors demanding their money back in significant numbers are simply forced to wait. 

The use of using open ended fund structures for property is therefore bound to come back under the spotlight. The industry has been here before and the mismatch between the theory that these funds provide flexibility and ease of access to investors’ capital and the reality when dealing with illiquid assets is once again apparent. Questions will not doubt be asked as to why higher minimum cash requirements are not regulated or other measures mandated to protect investors from having funds gated for periods of time. 

Nevertheless, it is unlikely that we will see any regulatory action judging  by the FCA’s  conclusions set out in its recent consultation paper released in September 2019 entitled Illiquid assets and open-ended funds and feedback to Consultation Paper CP18/27.

This broadly concluded that, as long as investors were aware of the inherent risks of fund structures of this type the FCA were not concerned with open ended funds investing in illiquid assets. Moreover, the risk management tools used by fund managers to protect all of the investors within the funds were largely approved. 

The FCA will, however, update its Handbook from 30 September 2020 and will require fund prospectuses to now clearly disclose the inherent risks of investment in illiquid assets and also provide a standard risk warning in financial promotions to retail clients for such funds. This will apply to all firms communicating a financial promotion, not just the fund manager.

For the time being it looks like gating is therefore  here to stay and investors will have to take a view as to the risks they are prepared to take. 

* At the time of writing no other flagship funds have followed suit and closed their gates but it is expected others will do so.