Regulators don’t always find it easy to spell out their views in straightforward terms – we’re left to read between the lines. So it appears to be with the Financial Conduct Authority’s publication this week of proposals to address the inherent liquidity flaws in open-ended property funds. Though the regulator stops short of saying so, its suggestions amount to a warning to steer clear.
Such a stark message would be hugely controversial, of course, and the FCA seems to have found a different way to get its thinking across. Rather than some sort of heavy-handed ban on open-ended property funds, the regulator is instead suggesting reforms that will drive the vast majority of investors elsewhere – most obviously into investment companies.
The regulator is, of course, right to be concerned. An open-ended fund invested in an asset as illiquid as property is bound to run into problems sooner or later. When too many investors want their money out, the manager faces the unpalatable options of a fire-sale of assets or a temporary suspension of withdrawals. Unfortunately, the property fund sector has found itself facing exactly this problem with remarkable regularity in recent years.
The FCA’s suggested remedy is that investors should be required to give 180 days’ notice when they want to take money out of an open-ended property fund. The idea is that such a period would give the manager enough time to arrange an orderly sale of assets where necessary – or for the immediate impacts of a market shock to dissipate.
So far, so sensible. But if the proposal goes ahead, why would any investor ever consider an open-ended fund? Effectively, they would be signing up for a fund with a built-in lock-in period, rather than the possibility of a bar on withdrawals in extreme circumstances. There is also the unpalatable possibility of such funds falling foul of the eligibility criteria for inclusion in tax-free individual savings accounts (Isas) because of such a notice requirement.
It is not as if investors do not have a perfectly good alternative to an open-ended property fund. The structure of a closed-ended fund heads off the liquidity mismatch issue. Whatever the prevailing market circumstances, investors in an investment company who want out can get out simply by selling their shares in the fund on the open market. The underlying portfolio is completely unaffected.
Leading financial advisers have reacted to the FCA’s proposals in recent days with something of a shrug of the shoulders. Their view appears to be that if the regulator wants to head in this direction, they will simply stop recommending open-ended property funds to their clients. Investment companies will take their place at the top of advisers’ buy lists for property exposure.
One rather suspects this is the outcome that the FCA is hoping for. It has no desire for a full-blooded confrontation with open-ended property fund managers and has therefore stopped short of more draconian measures. But it doesn’t need that kind of showdown – these latest proposals effectively sound the death knell for open-ended property investment in any case.