M&G property fund suspension hardly a surprise

Action could and should have been taken much earlier on fund mismatch problem

Giant property fund suspends sales – shock, horror! Oh, really? Seldom has there been a crisis more clearly signalled or where the warning signs have been blazing amber for so long. The decision by M&G to gate its £2.5 billion property fund followed a rising tide of investor redemptions – and it is unlikely to be alone in taking this action as other unit trust property funds are also suffering outflows.

Shock, horror? For the past two years it has been virtually impossible to open a newspaper or catch a news bulletin where the crisis in the high street retail sector and the demise of household name fashion and department store chains has not been recounted in torrid detail. But it is not just the front-of-store big names that are suffering. Also vulnerable are the giant pension funds, insurance companies and specialist property funds who own many of the retail buildings and who have been hit by falling rentals, leasing defaults and valuation downgrades as an ever-growing number of high street sites have emptied.

Out of the blue? Really? The immediate aftermath of the 2016 EU referendum brought a surge in open-ended property fund redemptions – including the M&G Property Fund itself. It was closed on 5 July of that year with sales suspended until early November.

M&G was not alone then – and it is very unlikely to be alone this time around. Its fund has been the hardest hit by withdrawals which hit £957 over the past 12 months. But other funds are also suffering an investor exodus through a combination of poor performance and fear of being trapped in troubled funds for an indefinite period.

The cause of the problem is the mismatch between open-ended or unit trust funds specialising in illiquid or potentially hard to sell assets which still enable investors to buy and sell at any time, and the nature of the underlying investments. Investors in star fund manager Neil Woodford’s Equity Income fund were spectacularly caught out in June when the fund, with an abnormally high level of holdings in unquoted or small, hard-to-trade company shares suspended dealings in the face of mounting redemptions.

Funds specialising in property are especially vulnerable. Selling a property to meet redemptions can take time, while investor redemptions tend to rise when commercial property valuations are under pressure or are falling, as they are now in the retail sector. Valuations can quickly become out of date and misleading. The M&G fund was vulnerable as it had just 5 per cent in cash and 40 per cent of its property portfolio in retail.

Bank of England Governor Mark Carney exposed the problem with uncharacteristic bluntness a few months ago when he said that funds holding illiquid assets but offering daily liquidity were “built on a lie” in the aftermath of the suspension of the Woodford Equity Income fund.

The open-ended fund mismatch problem has been so glaring and for so long that regulatory action could and should have been taken much earlier. But here again, investors have been let down. The Financial Conduct Authority has sounded warnings and has written to fund managers reminding them of their obligations to ensure adequate fund liquidity. But this doesn’t address the fundamental issue at heart: whether open-ended funds enabling investors to buy and sell at any time should be in the business of running specialist funds in hard to sell or illiquid assets. “

In all this, it is important to note the difference between a unit trust specialising in property and an investment trust. In the case of the latter, there is a fixed pool of capital used to build the underlying portfolio. When shares are traded, the trust is not forced to sell the underlying assets. Openended property funds, by contrast, have variable amounts of capital which rise and fall according to whether investors are putting money or taking money out of them.

However, trusts are not invulnerable: shares in a poorly performing trust can fall to a discount to the value of their underlying assets. Discounts currently range above 20 per cent for property trusts seen to be over-exposed to the retail sector.

How are leading open-ended funds positioned at present? The £3.1 billion Legal & General UK Property fund has 25 per cent of its portfolio in cash and 19.5 per cent in retail; Aviva Investors UK Property has 23.3 per cent of its portfolio in retail but holds 27.5 per cent in cash.

Questions are already being asked of the £1.4 billion Aberdeen UK Property fund which has 49.5 per cent of the portfolio in the retail sector and cash holdings of just 12.7 per cent. Investors have pulled £773 million from the fund over the last 12 months, according to Morningstar, during which time the fund has lost 7 per cent. The managers offloaded eight properties for a total of £207m in the first six months of this year.

Aberdeen Standard Investments, which houses both the Aberdeen fund and the £1.9bn Standard Life Investments UK Real Estate fund ( just over a third of which is in retail) says it will “continue to monitor the situation closely”.

And so should all investors in this troubled sector: other funds are likely to follow suit and suspend dealings in the coming weeks.