The Financial Conduct Authority’s (FCA) proposals to enable managers of open-ended funds investing in illiquid assets, such as property and infrastructure, to more easily suspend redemptions have divided opinion.
In a move designed to protect investors, the regulator has set out plans to make funds close much faster if there is another run on the asset class like back in June 2016, around the Brexit vote.
The proposals, which could also see property funds having to be badged as ‘high liquidity risk’ investments, remain open for consultation until the end of January 2019.
Under the plans, funds would suspend dealing when there is ‘material uncertainty’ expressed by an independent valuer about the valuation of at least 20% of the fund’s assets.
While the suggestions have mostly been welcomed by the industry, not everyone agrees that suspending redemptions more readily is a good idea.
However, Daniel Lockyer, CIO and fund manager at Hawksmoor Investment Management, said he believes the proposals are ‘sensible’ and a ‘good idea’ and serve to remind investors that open-ended property funds ‘do have setbacks’.
He would expect to see managers gating their funds more often in the future if the plans become regulation and funds have to badge themselves as a high liquidity risk.
‘If it’s well-known there’s a chance that these funds could be gated, I don’t think they will be as afraid to gate,’ he said.
‘They were more reluctant in the past because of the reputation damage, but if it’s considered more acceptable going forward, then it might happen more often, and that’s not a bad thing.
‘These funds have to hold a lot of cash to [meet daily liquidity], which they wouldn’t have to [in future].’
Ryan Hughes, head of active portfolios at AJ Bell, said he agrees that funds being able to suspend more easily ‘isn’t necessarily a bad thing’, pointing out it would help prevent those redeeming early unfairly getting ‘first mover advantage’ before a fund’s value is marked down.
It could also help prevent managers having to hold a fire-sale of assets to swiftly meet redemptions.
The elephant in the room
But Kames Capital, which contributed to the FCA’s original discussion paper ahead of its proposals going out to consultation, believes the suspension of property funds is something which should only be used ‘as a last resort’ when ‘existing liquidity has been eroded to a minimum level’.
Richard Peacock, who co-manages the Kames Property Income fund, said: ‘There is a risk that moving swiftly to suspend will incentivise managers to hold large illiquid assets rather than constructing portfolios that can deliver liquidity at all times as a result of asset lot size, location and quality.
‘The package of measures needs to reflect the other tools available to managers, including the maintenance of an acceptable liquidity buffer, the use of fair value adjustments in fund pricing and understanding investor concentration risks.’
However, the large levels of cash and cash equivalent property funds already hold as a buffer – over 24% a piece in the case of the Aberdeen UK Property and L&G UK Property funds – is a big issue for Alan Brierley, director of the investment companies team at Canaccord Genuity.
Brierley said: ‘When you’re running an open-ended fund, you’ve always got to keep an eye on what happens when the music stops.
‘Some of them are holding 20-25% cash. That’s fine, but it comes at a massive cost, especially when we live in a world where the return on cash is toxic.’
He echoes comments made by the Association of Investment Companies chief executive Ian Sayers, who welcomed moves to protect the consumer, but said the proposals ‘ignore the elephant in the room’ that the open-ended structure is not suited to holding illiquid assets.
Brierley believes the main issue is not when these funds gate, but rather the open-ended structure, and thinks ‘it’s difficult to see how you can get around the definition of illiquid assets’ in open-ended funds.
But holding real estate investment trusts (Reits) and closed-ended funds can be difficult for those who invest via platforms, an issue recognised by Lockyer, despite his Global Opportunities fund of funds investing in Reits and close-ended structures when it comes to property.
He believes that, for these investors, property equities could be the way forward.
He says: ‘I was at a meeting with a well-known fund manager in the asset class, who said that property equities behave like equities in the short-term, but are highly correlated with property in the long run.
‘It might be better holding a fund which owns property equity rather than direct property.’
An unintended consequence of the FCA’s property fund proposals could be the impact on multi-asset portfolios, writes Joshua Thurston.
Multi-asset funds will have to suspend trading of 20% of their portfolios held in suspended property funds.
‘It could lead a number of multi-asset funds to restrict the amount they hold in illiquid assets, such as property and infrastructure, so they avoid hitting this 20% rule,’ said Ryan Hughes, head of active portfolios at investment platform AJ Bell.
‘This will boost the liquidity of these funds, but means that investors may end up with a less diversified portfolio.’
Miton multi-asset fund manager Nick Greenwood questioned why multi-asset managers would gain exposure to these assets classes through open-ended funds anyway.
He said it would likely spark more investment trust alternatives being launched, describing this approach ‘just common sense’.