Commercial Property: Is there another way?

The question of fair value pricing and fund suspension was particularly topical in the aftermath of the EU Referendum in the context of commercial property funds.  Many had Fair Value Pricing (FVP) in place and some big funds suspended trading. Suspension of course, is a general power open to the Operator of any mutual fund regardless of the asset class.

The Operator of the fund is required to deal fairly to protect the interests of the remaining fund holders.  So in the event that asset valuations are not reliable then FVP is brought into play.  If liquidity is under threat or the market becomes unpredictable then suspension can follow.   These actions require the agreement of the Depositary, and in the event of a suspension, the FCA must be also be informed and the circumstances for the suspension regularly reviewed.  Sentiment and liquidity are the factors in play at this time.

The situation seemed driven by retail investors exiting, though there was press coverage of multi-asset funds having divested or being caught by suspension.

If an asset class is going to be used for a retail investor then a closed proposition is less likely to be attractive, withdrawal is always a forseeable scenario.

Then that brings us back to the fundamentals of real estate investing, and the UK market.  Opinions of the UK commercial property market, even before the referendum were generally that it was nearing a peak.  It does in the long run produce income positively correlated to (currently very low) inflation.  As a long term hold, it has characteristics that are attractive for some investors, but few would set anything other than a long investment horizon for it.

If we agree that the asset class can offer advantage to retail investors is there a better way of accessing it?  REITs and ETFs offer market traded liquidity, and in the long run are likely to be positively correlated to the property market.  In the short term however, they exhibit equity characteristics.  On the day following the referendum some showed reductions of 20% in value.  So the customer can obtain cash, albeit at cost.

Today funds operate on the basis of providing daily traded liquidity on assets that can take months to sell.  No surprise then that in times of stress, the need to suspend arises.  It also means that funds maintain liquid resources to manage redemptions, with some funds having had up to 20% in assets other than bricks and mortar in the period running up to the referendum.  Given that that the investor objective is returns from property, this is not a satisfactory position either.

An alternative is to look at the question slightly differently.  What if the funds changed the way that they operate so that a 6 month waiting period (say) were the norm?  This would better align to the fundamentals of the asset class that is the investment.

The funds would be able to maintain smaller average liquid balances as they would have a better idea of future liquidity requirements increasing the exposure to the desired assets.  The requirement for daily processing could be taken out by using a monthly cycle which could save a little cost.  The waiting period would offer the fund manager generally sufficient time to realise assets and result in a better alignment of achievability and customer expectation.

There would be impacts on the use of the funds inside ISAs as they stand, or in unit linked pension propositions, but nothing that could not be accommodated with limited adjustment to governing rules.

Note: This opinion piece was first published by Knadel Limited prior to the Catalyst-Sionic merger