Ian Sayers, Chief Executive of the AIC, learns to stop worrying and love notice periods.
‘Even investors who should have the longest horizons seem to have a fetish for liquidity,’ said the Bank of England recently. Striking language, but it highlights a contradiction in parts of the finance industry which lecture investors on the need to think long-term whilst treating daily redemption as sacrosanct. A sort of financial doublethink, to reference another dystopian classic.
Given this obsession with daily redemption, it’s not surprising that the FCA’s proposals for notice periods for property funds of, say, six months has been met with some resistance. However, the arguments offered against notice periods do not stand up to scrutiny:
Investors won’t like them
Only because they have been told for years that they can have daily redemption, so feel they are losing something. Investors also don’t like long suspensions, fire sales or funds holding large amounts of cash (on which fees are being charged) to try and prevent those suspensions and fire sales.
It reduces choice
Investors might like a fund that could guarantee daily dealing at asset value and full exposure to the asset class. Unfortunately, it doesn’t exist and never has. A false choice is not really a choice at all.
Disclosure is a better option
Good disclosure is necessary, but its track record in preventing consumer harm on its own is poor. Disclosure is not a substitute for having a robust structure which protects consumers.
They are complicated
Investors manage OK with fixed-term deposits. Notice periods are less complicated than suspensions, swing pricing, deferred redemptions, side pockets and other mechanisms suggested to tackle these problems.
Investors won’t know what price they will get
When investors in open-ended funds redeem their units, they are paid out of the assets of the fund. In times of market stress, it’s reasonable to wait and see what price can actually be achieved for properties that are being sold to meet redemptions. If the price ends up being lower than expected, why should remaining investors subsidise those who want to leave in the midst of a downturn?
They won’t work in model portfolios that need rebalancing
Then leave them out of the model and treat them as the client’s separate long-term holding. And how exactly do you rebalance a model portfolio if a fund has been suspended for nine months?
They won’t qualify for ISAs
Then change the ISA rules.
They will cause a flood of redemptions leading to more suspensions
If sensible changes have this impact, then it just confirms how unstable the current structure is and why reform is required.
Notice periods will lead to a reduction in investment in property/property funds
Probably the biggest myth of them all. In Germany, property funds require one year’s notice to redeem investors’ units. The chart below shows net inflows/outflows for German property funds compared to the UK.
In the last two years, the UK has seen consistent outflows, stemmed in recent months by widespread suspensions. By contrast, Germany has seen inflows, even in the post-COVID period.
Since July 2018, the German sector has grown from £77bn to £101bn*. The UK sector has shrunk from £19bn to £13bn. The idea that notice periods are ‘bad for business’ is simply not true.
If we get notice periods right, investors will have a genuine choice. An open-ended fund which can remain fully invested, which investors can leave at asset value on giving reasonable notice. Or a closed-ended investment company, which investors can leave at any time at a price determined by the stock market.
Either structure will perform exactly as intended, and neither will require fire sales at times of market stress which not only harm investors in the fund, but also spread contagion to other funds and the broader economy.
A brave new world, perhaps?
* UK and German fund flows and asset sizes excluding feeder funds and fund of funds. Source: Morningstar.