Triggered by the belated realization of the risks in mutual funds that offer daily liquidity but invest in illiquid assets.
By Nick Corbishley, for WOLF STREET:
Over the past two days, 10 open-end property funds in the UK have slammed their doors shut on investors, citing concerns about asset valuation. The funds’ two property valuers, CBRE and Knight Frank, say that it is currently impossible to accurately value the funds’ real estate assets amid the market chaos being caused by the response to Covid-19.
“The UK commercial property market is facing unprecedented circumstances as a result of the COVID-19 outbreak, and so valuation firms can no longer make reliable judgement on value. This is known as ‘material value uncertainty’,” said Paul Richards, managing director of the Association of Real Estate Funds (AREF), in a statement. To justify the fund suspensions, Richards cited new FCA rules applying to funds investing in inherently illiquid assets, such as commercial property:
“Funds with more than 20% of their portfolio subject to material valuation uncertainty are required to suspend subscriptions and redemptions in the interests of all investors. Although these rules are not due to come into force until September 2020, existing rules would require fund managers to consider suspending funds in circumstances like the ones they are facing at the current time.”
The first fund to shut its doors was Kames Property Income, with £504 million under management. That was on Tuesday. By Wednesday morning, Janus Henderson and Aviva, which respectively manage property portfolios worth £2 billion and £461 million, had followed suit. Then, over the next 24 hours, another seven funds did the same.
Between them, these funds manage some £11 billion of assets, equivalent to around a third of the total assets under management in the UK’s property fund sector. They invest in commercial real estate across the UK including offices, industrial property and retail parks, a sector beleaguered by retailer failures and crushed values. Just this week, one of the UK’s largest mall owners, Intu, warned that it was on the verge of bankruptcy after posting a £2 billion loss and a 22% plunge in the net asset value of its commercial properties.
Now, it’s the property fund sector that’s beginning to wobble. That includes the sector’s biggest player, the £2.9 billion Legal & General UK Property, which, like AREF, justified its decision to suspend redemptions by citing the “unprecedented set of circumstances caused by the COVID-19 virus” and its impact on “market activity across all sectors”:
“This means that “independent valuers are unable to rely on previous market experience to inform their opinion of values of the properties held by the Fund. We believe this suspension to be the fairest outcome for all investors, taking an appropriate forward looking view through the current crisis.”
Other large funds that have suspended redemptions include the £2 billion Janus Henderson UK Property, the £1.7 billion Standard Life Investments UK Real Estate, the £1.1 billion Threadneedle UK Property and the £1.1 Aberdeen UK Property. These open-end mutual funds are particularly prone to liquidity crises in the event of market sell-offs, as the Bank of England’s Financial Policy Committee warned repeatedly, starting in 2015.
When investors take their money out, the fund will use up the remaining cash and then has to sell assets in the portfolio to raise money to meet the redemptions. This is normally not a problem when the assets in question are highly liquid, such as large-cap publicly traded stocks. But when the assets are commercial real estate that can take weeks or months to sell, if they can be sold at all in a hurry, particularly in a downturn, there is a mismatch in liquidity between what the fund offers to its investors (daily liquidity) and what the fund holds (largely illiquid assets). Eventually, the fund runs out of cash and has no choice but to close its doors, leaving investors trapped and having to contemplate big losses.
In June 2016, in the aftermath of the Brexit vote, six commercial real estate (CRE) funds suspended redemptions. Now, things are even worse than that.
Almost all of the funds that shuttered this week blame their decision on valuation concerns. Words like “volatility”, “liquidity” and “cashflow constraints” were conspicuously absent from the press releases. BMO explicitly emphasized that the suspension of its two funds was “not related to any liquidity event”, which is curious given that many of these funds were already suffering a sustained wave of withdrawals long before the coronavirus struck.
In 2019, UK property funds suffered record outflows of £2.2 billion, equivalent to one in every 15 pounds of assets under management, according to investment funds transaction network Calastone. The sector has suffered net withdrawals in every quarter since 4Q-2018. By the end of last year, things had gotten so bad that M&G Investments, the fund management arm of UK insurance giant Prudential, decided to halt dealings in its direct property fund, which has more than £2.5 billion in assets under management, as well as its feeder fund.
Unlike its peers that suspended withdrawals this week, M&G made the decision to suspend its property portfolio after “unusually high and sustained outflows” triggered by “Brexit-related political uncertainty and ongoing structural shifts in the UK retail sector.” According to Morningstar, the portfolio had had only one month of positive flows since Britain voted to leave the EU in June 2016.
The gating of M&G in December, just two months after the closure of the £3.7 billion Woodford Equity Income fund which left investors facing losses of more than half of their money, has seriously spooked investors, who finally began to realize the dangers of entrusting their money with funds that offer daily withdrawals while investing in highly illiquid assets. This realization has turned into a run on the funds, forcing the other large open-end property mutual funds to close their gates, all at virtually the same time. By Nick Corbishley, for WOLF STREET.
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