Open-ended commercial property funds are once again at the centre of a Brexit storm. The Financial Conduct Authority was reported this week to be monitoring a rise in investor withdrawals which it is feared could lead to a repeat of late 2016 when many such funds were forced to suspend trading, temporarily preventing investors from taking out their money.
We gathered four property investment experts to debate the pros and cons of closed-end real estate investment trusts and property investment companies. While not perfect, these stock market listed funds have generated superior investor returns and have not been subject to the suspensions that open-ended funds have been.
Our speakers were:
- Alan Brierley, head of investment company research, Canaccord Genuity (pictured above);
- Calum Bruce, investment director, Ediston Real Estate, manager of Ediston Property Investment Company (EPIC)
- Ben Yearsley, director, Shore Financial Planning
- Rogier Quirijns, head of Europe Real Estate, Cohen & Steers
Can't watch now? Read the transcript
Gavin Lumsden: Rogier, you run an open-ended fund that invests in closed-ended funds, real estate investment trusts, that’s what your fund invests in, so you’re a great person to talk to about this. Can you just remind us, summarise, what happened in 2016 after the Brexit vote?
Rogier Quirijns, Cohen & Steers: So what has happened after the vote was you could see a lot of panic in the market. People selling, so the stocks coming down significantly and you could see people withdrawing money, and what can we do, we can sell stocks in the market and raise the capital at the same day these events happen. And on the other hand, the open-ended funds that are invested in non-listed property, they have a bigger issue because they do not have the daily liquidity. They can’t sell a property the next day.
GL: So investors were trying to sell out of these funds and the managers of these funds couldn’t sell their assets quick enough? They didn’t have enough cash to give to the people who wanted to get out. And they had to sell properties and that, we all know, takes weeks, months.
RQ: Weeks, months probably. And in a market where there’s a lot of people trying to sell more assets.
GL: OK thank you Rogier. Turning to you Ben. What was the impact on investors? The trouble is when the news of these big open-ended property funds suspending gets out it starts to undermine sentiment in the property market, people expect these property funds to start selling. So what was the impact on your clients?
Ben Yearsley, Shore Financial Planning: The impact was interesting actually. The fund suspensions we’re coming on to talk about prevented investors from panicking and selling, because they couldn’t. So whereas they might have gone into the market and sold equities – don’t forget the stock market fell 500-600 points that day after the referendum, so people were panic selling everything. The fact they couldn’t actually sell property funds, the open-ended property funds, because of the suspensions actually saved them from making financial mistakes. They were tied in and the managers actually had time to liquidate enough property sensibly. However, leaving that to one side, they obviously couldn’t do anything. They couldn’t put new money in once those funds were closed and, in the open-ended property funds, they couldn’t sell. So if you really wanted your capital out, you couldn’t get it. But at least you were saved from making a short-term panic sell that would have cost you more money.
GL: Calum, the Financial Conduct Authority has come out with proposals to stop this happening again. What’s it suggesting?
Calum Bruce, Ediston Real Estate: What the FCA is trying to do is just protect the investors, which is absolutely the right thing to do. So they are proposing a series of things they can do to try and prevent a run on units, to prevent this sell-down in a period of volatility. They’re talking about suspensions when there’s material uncertainty I think on 20% of scheme property, they’re looking at dilution levies, dilution adjustments and fair value adjustments that we’ve talked about. They’re also looking at putting a, I suppose, warning labels, is how you would describe them, on these vehicles to alert investors to the fact that investing in a property which is illiquid, investing in something that can’t be sold readily in a time of market uncertainty.
GL: Alan, let’s turn to you. You’ve recently done some research comparing the returns of property investment companies – the closed end versions – versus their open-ended rivals, which tend to be much bigger, most of the money is in the open-ended.
Alan Brierley, Canaccord Genuity: Although I welcome the consultation by the FCA, I think they’re missing the point here. The reality is illiquid assets are not suited for the open-ended format.
GL: Your research seemed to highlight that the managers of the open-ended funds to deal with the risk that people might want to take their money out, they were holding large amounts of cash and that erodes their returns.
AB: Exactly. There’s two sides to this. When the markets are sort of performing well, property is going up, we tend to see a lot of flows of retail money and institutional into the asset class, into open-ended funds. The managers have to go out and invest this in the underlying properties. Again, we’re back to illiquid asset classes. The flip side of that is when we have a more risk-off market, what we tend to find for investors looking to take their money out, that managers are forced sellers. They’re having to invest in very buoyant markets when prices are moving against them and exactly the same happens on the opposite side. They’re basically forced sellers of assets in a market where there’s not many bids.
GL: The highlights coming out of your research in October were pretty striking. Average direct property exposure in the investment companies was 131%. That’s because of the borrowing or gearing you were talking about earlier on, they can invest more.
BY: That’s why they’re not necessarily suitable for everybody because of the gearing effect. It’s the risk bit that gets forgotten with investment companies is that actually in a downward market that gearing is going to have a double-negative effect.
GL: In rising markets, you go up more …
BY: It’s brilliant
GL: … but you fall faster.
BY: Yes it’s a problem. The open-ended space can work for illiquid assets but I think it needs to be more of a hybrid model. At the moment the hybrid is cash and property. That doesn’t work because all the managers charge full fees on the cash and they don’t do anything for it. Actually it’s a disgrace actually and they’re holding 20, 22% cash. But actually a hybrid of direct property and liquid property shares is possibly the model to go down if you want to keep open-ended partially in property at least you’ve got liquidity. I think long term that’s probably the model that will work well than 20% cash and 80% property which in my view doesn’t actually work.
GL: Roger what do you think of that? You invest in equities.
RQ: Yes, definitely, 100% equities. Just before I answer that question, as you can hear I’m Dutch and we used to have open-ended funds, Rodamco in the old days used to be open ended. We closed them in the 1980s because of a crisis because of exactly that reason. You know when a market is hot, a lot of money comes in and you have to buy, but when the market is weak you a forced seller. So we’ve dealt with that issue.
GL: So in the Netherlands if a fund wants to invest in physical property it has to be closed end.
RQ: Well there are certain private funds which are kind of open-ended but on the stock market, the Rodamcos, what used to be Unibail, we close ended them in a big crisis in the 1990s.
GL: Closed-end funds aren’t perfect, their shares, as Ben was saying, can fall if the gearing works against them but also the shares can fall to discounts and rise to premiums , you know they’re volatile. Whereas with the open-ended funds, what you see is what you get. The unit price is the price.
AB: Yes exactly the price you to pay for investment trusts is you do get premium discount volatility so if we went back four or five years a lot of the companies were trading on 14-15% premia. And at the moment they’ve sort of fallen out of favour. Because we have a sort of Brexit discount.
GL: Yes in your report you highlight the example of a trust trading on a 20% premium above its underlying net asset value and then a year-and-a-half later it’s trading below that. If you’d bought in at the top end and you sell at the bottom end, you’ve lost a lot of money.
AB: Exactly. I think that’s a risk. Coming back to Calum’s point. This is a long-term asset class. After the FCA report we did actually have a look into the two main, different types of funds. We looked at the nine general UK funds – so there’s no cherry picking – and we chose eight of the largest open-ended property funds. The performance is quite stark. It comes back to this point about the exposure levels so at the moment the average exposure of investment trusts is 131%, the average unit trust is 78%. And so you get a lot greater efficiency in terms of your exposure.
GL: So on average, the average open-ended fund is sitting on 22% cash?
AB: At this moment in time it’s cash or liquid assets.
BY: But if you look at the five-year numbers, returns, the open-ended funds have on average done 38% over five years. And the investment trusts have done around 46%. Now in my mind that’s not enough differential for having a 50% difference in property exposure. So something isn’t quite right, that property exposure isn’t translating necessarily into the excess performance you’d expect.
GL: You’d expect the property investment companies to do better given they’ve got so much more exposure to property?
AB: I think that’s looking at shareholder total return and that obviously includes the de-rating that you’ve spoken about. It’s interesting over five years
BY: But that’s what investors get though.
AB: Exactly but it depends on where you cut it. Over 10 years, which is an even better time period, the shareholder total return from investment trusts is 11% [a year] from unit trusts it’s 4.3%, it’s a massive difference. The total shareholder return, what shareholders get, is 182%. Investors in the unit trusts would have got 53%. It’s three times, it’s a massive, massive difference.
GL: What should the FCA be doing?
CB: I think they need to be promoting the Reit structure or the …
GL: Real estate investment trust.
CB: … real estate investment trust, the closed-end structure more. It’s glossed over that as an option in that paper which I think was a little bit dismissive, I think there’s good reasons to hold the closed-end companies in a portfolio.
GL: What would you tell the FCA, the Financial Conduct Authority? What should it do?
RQ: I would start at the basics and do much more research on where the highest returns are and that’s coming back to that paper. And we’ve done a lot of research in the US and also globally. You see it coming back everywhere, listed, liquid is generating a higher return, lower risk versus the open-ended, private. So I think that’s the basic.
GL: OK Rogier, gentlemen, thank you very much for your views. I think it’s clear the FCA needs to do a little bit more work on this one. Thanks for your time.