Liquidity Crunch Mangles UK Equity & Real Estate Funds

Exodus from funds with illiquid assets forces more funds to block redemptions.

By Nick Corbishley, for WOLF STREET:

Equity and property funds in the UK saw withdrawals of £2.5 billion in July, taking total outflows in 2019 so far to £12.4 billion, according to Morning Star data. Equity funds, with total assets of £691 billion, were down £1.6 billion in July and £10.6 billion so far this year. In a broad flight to safety, money market funds experienced their sixth consecutive month of inflows while investors poured £428 million into Fixed Income funds.

Morning Star analysts blamed the outflows from equity and property funds on fears over a UK recession and a no-deal Brexit. But there’s also a structural element at work: the mismatch in open-ended equity and property funds that offer investors daily redemptions while investing in assets that can take weeks or months to sell.

Few funds are as illiquid by nature as commercial property funds, which suffered £2.2 billion of outflows in the first seven months of this year. Just two funds — M&G Property Portfolio and Aberdeen UK Property — accounted for 89% of the £417 million of outflows in July.

“The prices of commercial property – which accounts for most of these funds’ investments – are heavily influenced by the macro environment and if investors believe a downturn is ahead, they are less likely to invest in property funds,” said Morningstar analyst Bhavik Parekh.

At M&G Property Portfolio, the outflows recently turned into a torrent, which then turned into a classic run on the fund, and managers ended up blocking redemptions as they tried to offload properties in the portfolio, including British retail parks, offices and industry property. Selling these assets at survivable prices, rather than fire sale prices, can take months or longer.

The gating of the fund stoked fears of a replay of the chaos that briefly swept the UK’s property fund sector in the wake of the Brexit vote in late June 2016, when the value of commercial real estate in the City of London crashed 6% in just one month and six commercial real estate funds, including M&G, temporarily suspended redemptions as panicked investors rushed for the exits.

To try to prevent that from happening again, some open-ended property funds are penalizing investors who cash in their holdings by marking down the value of the underlying properties in the fund. The latest fund to do so, BMO Holding, said it has (in the industry’s jargon) changed its fund pricing from “offer” to “bid”, leaving investors who dare to sell the fund shouldering an instant loss of approximately 6.4%.

“With heightened uncertainty in the UK property market, in part driven by the increased risks of a ‘no-deal’ exit from the EU, a number of investors in the sector have looked to trim their exposure. As such, the fund has seen modest outflows,” said Guy Glover, fund manager of BMO UK Property.

It’s not just fear that is driving investors to withdraw their money from property funds; there’s also widespread disappointment at the dwindling returns on offer, due in part to the larger cash buffers the funds have had to build up to try to avoid a rerun of Summer 2016. In May, the average level of cash exposure for UK direct property funds reached 19.5%, up from 14.6% in May 2016, according to the FT.

In expanding their cash buffers, open-ended property funds now have less money on hand to invest in actual income-generating assets. Funds in the Investment Association’s UK direct property sector generated average annualized returns of 4.4% over the three years to the end of June — 42% less than the 7.6% returns notched up during the previous three-year period.

With a no-deal Brexit looming ever larger, funds can be forgiven for toeing a cautious line, especially in light of recent developments at the £3.9 billion Woodford Equity Income Fund (WEIF), where a run on the fund prompted its manager, former hedge-fund legend Neil Woodford, to place a ban on redemptions. Over 300,000 (mainly retail) investors were left trapped with no means of accessing their funds.

What many of those investors hadn’t realized was that although WEIF was offering daily liquidity, most of its assets were extremely illiquid. By the end of May, the fund’s holdings of lightly traded micro-, small- and mid-cap stocks accounted for 97% its assets, according to Morning Star data.

The suspension on redemptions at Woodford has already been extended until December as the fund struggles to sell those assets. WEIF has already fallen by 11.2% since the suspension, compared with a 1.5% gain on its benchmark index, the FTSE All Share Total Return. Fears are growing that it may never reopen at all.

The Bank of England in July reiterated a warning it first issued in 2015 about “the vulnerabilities associated with liquidity mismatch in funds that offered short-term redemptions while investing in longer-dated and potentially illiquid assets.” Aside from requesting a fresh review of open-ended funds, which are estimated to hold some $30 trillion in assets globally, the central bank has taken no other action.

Some investors appear to be already taking matters into their own hands by yanking their money from other open-ended equity income funds. So far this year, over £10 billion has been pulled from UK equity funds. The Silver-rated JOHCM UK Equity Income fund, one of the 10 worst performers in July, suffered its largest ever monthly outflows, with £257 million withdrawn from the fund in the month. Neutral-rated Majedie UK Equity suffered outflows of £200 million.

The UK is home to more than 3,200 open-ended funds, which have total assets under management (AUM) of £1.5 trillion, up from £484 billion a decade ago, according to the Financial Conduct Authority. If the current pace of outflows from these funds continues, or even picks up in the event of a no-deal Brexit, the risk,as Bank of England governor Mark Carney recently warned, could very quickly become systemic. By Nick Corbishley, for WOLF STREET.

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  43 comments for “Liquidity Crunch Mangles UK Equity & Real Estate Funds

  1. Leser says:

    M&G and Aberdeen are big names in the UK and considered blue chips. This is ominous and anybody not reviewing their portfolio now under the aspect of liquidity risk does so at one’s own peril.

    And there is a mountain of ETFs piled up to the stratosphere behind that waiting for a true liquidity test of their instruments and underlying markets.

    There will be a time when a lot of people will have to wait patiently outside closed gates to get their money back.

  2. John says:

    Ha, good luck getting your money back at that point in time. It will all have trickled UP by then.

  3. Marc says:

    I really don’t know why this is a big surprise to anyone here in the UK. Retail properties shops and restaurants are failing at an alarming rate the high street and even the shopping malls are losing footfall and spending to online services. The days of when retail property was a guarantee of making money are long over and I doubt will return any time soon. You can thank over inflated business rates and parking charges and fines for killing of the high street. There is so much office space at absurd prices in major cities that landlords can no longer name their price and give huge rent rises and get away with it either. Everything is over inflated and shows no real value just paper gains that as many are finding out can’t be converted to real gains or cash out from. When this debt and credit bubble blows its going to decimate the value many think they are holding IMO.

    • Wisoot says:

      Any person with an ounce of logic is waiting it out until Brexit (not hard and not soft, just Brexit) is delivered. That means holidaying less, upgrading less, less DIY, less moving house, less everything. Until the average Brit can see down the road, they will not spend. They will dodge the risky stockmarket and hold savings in items of barter value. Its risk management and quite normal. Who is to say when the road is clear, we will return to old days ways. I think we are on the edge of a paradigm shift and there is no going back. Carney wants a currency reset and possible debt cancellation.

    • Capt Smith says:

      Plus, nobody in their right mind who is outside the UK would want an investment denominated in pounds. Even if the investment stayed flat, the value of the pound has fallen 18% against the dollar since June 2016. You’d have to find a perfect, super, high-return paying investment just to make up for currency that sinking like the British built Titantic.

      • char says:

        Pound should not be compared with the dollar but with the Euro of which it is a satellite currency.

  4. mitch bollinger says:

    Guy Glover of BMO should get an award for Orwellian double speak. It is brilliant to tell investors that they don’t need to mark their assets down because they have only lost value if they want to sell them.

  5. David Hall says:

    Equity income fund reads like dividend stock fund. There are many high quality dividend paying companies. There are also zombie dividend paying companies with damaged balance sheets.

    Bond investor Mohamed El Erian recently predicted a 70% chance of a European recession.

  6. J.M. Keynes says:

    – Brexit is used as an excuse over and over again to obfuscate the REAL reason for the dismal economic performance of the UK economy.
    – Look at the GBP instead. Both the EUR (60% of food the british consume is imported from the Eurozone) and the USD (think: oil & commodities) have risen some 30% against the GBP. And the british consumer didn’t get a 30% wage raise to compensate for that falling GBP.

    • Keeper Hill says:

      Last I looked before the crisis somehow the pound was over 2. It never belonged there either. The British economy cannot sustain on royal family photos alone.

      • Capt Smith says:

        A check of a 10 year chart of GBP:USD shows it hasn’t been above 2.0 in those 10 years. I’ve got grey hairs and I think I do recall it being at 2:1 to the dollar at some point, but it wasn’t in the last ten years. The high in that time was about 1.71. It was at a peak of about 1.4662 in June of 2016. It hit 1.2036 in August. Who knows what it will be after Nov 1, but I certainly wouldn’t bet any money on it going up.

        • Caradoc says:

          Look into the 8 year GBP cycle. It does exist and low now. Personally, no surprise if problem 2-3 yra after Brexit is keeping the GBP down.

    • Wisoot says:

      “REAL reason for the dismal economic performance of the UK economy” = altruistic monetary system fix. Think about it. Just a minute. Really think. Starvation can not exist alongside wealthy societies. Until wealthy societies feel a little of starvation, they can not hope to fix the global starvation. This is an altruistic (break the monetary system for the greater good of all humankind) fix. There is no reason to the stock market and monetary policies because the economists are being told to hold the fort while the sociologists balance wealth. That is why the pound has leveled to the dollar and euro. It is with the aim of one global currency. The only thing that seems unfair is the investors who are still playing the old game (waiting for currencies to get back to old levels) and haven’t cottoned on to the new game. The new game is not for you to generate wealth globally. It is for you to invest in your local and regional economies where ROI has a lower guaranteed percentage gain. This is the only way to avoid what is coming next.

  7. Willy2 says:

    – Off topic: Real estate in New Zealand is VERY overpriced but vested interests don’t want you to know that.

    • Nicko2 says:

      Also, thanks to reliance on dairy industry, virtually all fresh water sources in New Zealand are contaminated. Pristine wilderness as depicted in the Lord of the Rings Movies…it is not.

  8. Old Engineer says:

    I would think once a run starts on a commercial property fund it would become very difficult to sell properties at at a “survivable price” as buyers would know how desperate the fund was to raise cash. I’m surprised they don’t just borrow the money against some of the properties to pay off the investors. They could then wait for better times to sell.

  9. unit472 says:

    Besides brick and mortar retail losing ground to internet sales, commercial property has other headwinds. Gone are the huge trade surpluses of OPEC and China. There is no need to invest them in Western property markets if they can even get their money out. I doubt many Saudi’s, e.g., are eager to hang around upside down in the Riyahd Ritz Carlton and China’s rich have to be careful too if they can even get their money out now.

  10. Jon_Dough says:

    Time for Wolf to provide a refresher on the “normal” cyclical nature of this stuff and remind all why the central banks interference (at the behest of politicians) is so destructive. Fundamentals are of little to no importance. Now it is more of a media driven circus/casino. Plan for the future and invest wisely!! Now a conceptual joke…..

    • cesqy says:

      1. Economics is a dismal social science.
      2. Most social science experiments are not repeatable.
      3. This recession will be different.

      • Wisoot says:

        Had to explain to a young family member who recently got A’s in math that if she wanted to study economics in future, she should prepare to learn theories that do not reflect reality. She was a little disappointed. I explained that during my economics lessons, I would raise my hand and give a real world example of how this or that particular model failed and the lecturer would reply with a wry smile. “These models are only indicative and not definitive”. So what is the point of them? Economists need models to reflect safely extractable country resources with any kickbacks (detrimental to sustainable living) factored into the model (which of course makes things complicated). Bio regionalism is where we are all headed with a blockchain connectedness. Communitiies looking after valleys, waterways, mountains and plains. See Didier Prost on bio regionalism.

    • Petunia says:

      Economics was traditionally a subset of political philosophy. Now it is more aligned with data mining and economic manipulation, called data science.

      The models need to reflect new realities, such as: bank sees more spending at xyz corp, they go long on the stock or options, spending at abc corp are lower than normal, go short. It’s all about front running data.

  11. tommy runner says:

    a note from the boe to those in the redemption line aka ‘the supply of productive finance’
    ‘The Bank and the FCA will together assess how funds’ redemption terms might be better aligned with the liquidity of their assets in order to minimise financial stability risks without compromising the supply of productive finance’.
    commodities update: abundant supply of wool this winter.

  12. envo says:

    We the Global Financial CRISIS – and central banks pumped out epic stimulus etc to prevent a collapse.

    Next up will be Global Financial COLLAPSE and it will be permanent.

    Because the central banks will do absolutely everything to fend it off, and will fail. At that point there will be nothing left in the tool kit.

    Think of it like owning a magnificent horse. Loading him up with a few hundred kg of gear then pushing him to the limit.

    Eventually he staggers then falls. You then beat him and inject him with stimulants to get him back on his feet.

    He soldiers on for a few more km then falls again. You inject him with 10x the dosages and flail him.

    He struggles up but then collapses in a heap. You inject him with the lot.

    He twitches.

    Then his heart stops.

    He is dead. Nothing you can do will bring him back

  13. Tom Stone says:

    A loss of 6.4% might look real good in a year…
    Knowing when to fold’em is a hard earned skill.

    • Leser says:

      That’s a fair call. What had contributed to liquidity in UK commercial property in the last few years was the boom in warehouses for online retailers, and most recently another bump in businesses looking for emergency stock storage space for Brexit contingency. Both seem to have levelled off now.

      As mentioned above, office space has been stagnant for a while and retail space outside of very few hot spots is dire. Even in the better-off towns in the richer southeast of England, town centres are dominated by pound shops, gambling parlours, food and coffee chains, and a lot of charity shops who don’t pay business rates.

      • Wisoot says:

        Commerical warehouse property market losely aligned to infrastructure provision at some point in the last 10 years changed. It wasn’t an intentional change and it isn’t a positive one. At some point in the last 10 years, councils with cut budgets decided to hoard central government money in contingency funds on their balance sheets and after some nudging with the glare of inefficiency being whispered about, decided to invest in commercial property. So what we have is government investment in a supposedly open market. Not a government investment which is coordinated. No. It is chaotic. That is why high street prices and landlords have not dropped prices for the sake of the economy because local government would lose, and taxpayer alliance would be on their backs. So what we have is a horrible imbalanced market corrupted by public money interferring with natural market forces. The thing that irritates me the most. When council acts using public policy to protect its private investment. That is when you know capital markets are dead. So taxpayer wins against Joe Bloggs investments as they always have the judge on their side and the upper hand in inside policy knowledge of future investments. It stinks. It is corrupt. It is broken.

      • Brant Lee says:

        What is a pound shop?

        • MC01 says:

          British version of Dollar General, Dollar Tree and the like.

        • Pete says:

          What is a pound shop?

          Pound shops started cropping up in the UK in about 1982. (Poundstretcher) They typically sell cheap item’s such as nearly out of date sugary food, or cheap Chinese manufacturered toys. Kitchen and bathroom essentials. All for a pound or very near to the price of a pound. Poorer people started flocking into these cheap stores to buy all the cheaper products.
          I saw these types of shops as the beginning of the demise of the UK town centre shopping areas.

  14. implicit says:

    UK R.E. problems will spread to the U.S eventually, regardless of the early induced Brexit excuse, knocking them down from their lofty record highs as safe defensive havens. Preemptive early withdrawal would be wise in the “great U.S economy” to prevent loss of funds. Just a matter of time. Tick tock

  15. Kenny Logouts says:

    Exactly, everyone can’t sell at the top. You need buyers.

    People seem to forget that when they put wealth in anything but cash, liquidity is based on buyers wanting it at the price you want to sell.

    People need to get real.

    If they cost average bought, and took profits, then they should have done ok.

    If they’ve bought in late on the hype train trying to game things. Ouch.

  16. Iamafan says:

    Who invests in these things? Have we learned anything in 07-09?

  17. Not to worry we are drowning in a sea of liquidity, there is money out there ready and willing to prop up a run on the funds, and indemnify their losses (at such a level that it does not impair the entire system). There is no point in buying assets for pennies on the dollars when that marks to market lower assets you already hold. You can imagine a moment when a buyer with no stocks says, well okay, maybe a little, but an investor who already owns a large position is cutting their own throat. By premise one the EU will be the buyer of first and last resort, if by other means.(nirp)

  18. Realist says:

    Well, when all else fail, they’ll take you into war ( not my saying, but it fits so nicely into today’s World as always )

  19. DR DOOM says:

    The fiat deluge of 2009 denied the grim reaper of excess its rightful spoils, mark to market. The old dead white guy from Edinburg and his silent hand of the market and the reaper are stirring.Prepare yourself.

  20. ML says:

    The state of the retail market in UK has not adversely affected the commercial property investment market – yet. Although in theory prospects for rental growth should affect the prices for the investment, in practice the relationship decoupled years ago. The primary influencing factor now is interest rates. High prices are largely symptomatic of yield compression. As and when interest rates rise, the investment market will suffer. In the meantime, investors continue to buy at sub 5% yields as if there were no tomorrow.

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