The conundrum of open-ended property funds

Property Funds can be either closed ended or open ended. In a closed ended fund (such as a Real Estate Investment Trust or “REIT”), the amount of equity invested is fixed and investors may gain liquidity by selling their shares in the market. In an open ended fund, units or shares are created and cancelled as investors invest and divest in the fund. The main advantage of an open ended fund is that units are created and cancelled at or about net asset value, whereas listed shares in property funds often trade at a significant discount or premium to net asset value.

One consequence of this distinction has been highlighted again recently as a number of open ended funds were unable to meet the demand for redemptions in the aftermath of the Brexit referendum. The amount of redemptions requested by investors exceeded the liquidity of the funds to meet them. As a consequence, the funds had to “gate” redemptions and investors could not redeem when they wishes to.

This has led to renewed questioning as to whether it is appropriate for funds with illiquid asset classes (such as property) to be open ended in nature and if so, whether additional measures should be introduced to improve their ability to redeem shares in times of unusual investor demand so that investors do not have to wait months for properties to be sold to raise redemption monies. These funds can also be pushed into being forced sellers of property in falling markets, increase downward pressure on property prices.

The bank of England first raised concerns about this issue in 2015 and it has been explored by the Association of Real Estate Funds (AREF) and the FCA in recent reports. No definitive decisions have been taken, but measures under consideration are:

  • 1 Requiring funds to hold more cash or other liquid assets. This would mitigate the issue but can significantly reduce investment returns.
  • 2 Funds holding a wider spread of properties so that lower value properties can be sold more quickly as necessary.
  • 3 Offering redemption periods to institutional investors of say a month or even a year as well as offering retail investors daily dealing.
  • 4 The FCA taking a more direct role in requiring managers to suspend dealings in their funds.
  • 5 Requiring managers to disclose illiquidity risk to investors more clearly.
  • 6 Promoting the ability to make sales of units in the secondary market as an alternative to redemption.

This problem is as old as open-ended property funds, but it does seem that the industry is moving towards taking measures to significantly reduce difficulties in the future.