Shaky foundations

Slowly but surely, confidence appears to be draining away from open-ended property funds. The announcement in recent days by Aviva that it is to permanently close its £400m UK Property Fund is just the latest in a string of setbacks for the sector, which is still subject to a regulatory review. The Financial Conduct Authority is trying to come up with an alternative fund structure to resolve the fundamental problem with open-ended property vehicles: the mismatch between the liquidity they offer investors and the illiquidity of their portfolios.

We should be fair. Analysts point out that Aviva’s fund has particular characteristics that have driven the fund manager’s decision. In particular, the fund is small compared to many of its counterparts, which makes the liquidity issue even tougher to manage. Other open-ended funds in the sector do not face the same pressures and will not follow Aviva’s lead, these analysts argue.

Maybe not, at least in the near future. Nevertheless, this move is yet another tacit admission that the open-ended structure is not a suitable one for those investors seeking exposure to physical property assets. And the FCA’s ongoing determination to find a fudge for that seemingly intractable problem simply begs another question – what is wrong with the existing alternative fund structure we have.

That, of course, is an investment company – a closed-ended fund where the daily dealing in shares on a liquid stock market continues with precisely no implications for the underlying portfolio. Investors who want to buy or sell can do so at will. Meanwhile, the fund manager gets on with managing the assets – free to sell property at a time of his or her choosing, or not, depending on the investment case.

The reality, we know, is that no regulator would ever intervene in the marketplace with the decisiveness and ruthlessness that directing investors away from one type of fund to a competing structure would constitute. Hence the FCA’s efforts to find compromises and alternatives.

Still, one could not help noting the juxtaposition of two news stories in the personal finance pages this week: coverage of the Aviva closure appeared alongside reports of a flood of income-focused investors targeting commercial property investment companies.

There are good reasons for this. In a tough commercial property market, shares in many investment companies in the sector are trading at substantial discounts to the value of the underlying portfolio. As a consequence, the yields on offer from many of these funds look very attractive – all the more so, given the dismal outlook for interest rates right now.

It is worth pointing out too that investment companies in commercial property come in a variety of forms. There certainly are generalists, whose exposures include holdings in the office and retail sector, where investors have particular worries in the current market environment. But there are also more specialist funds – including those with a keen interest in logistics assets such as warehousing, which look set to continue benefitting from the boom in e-commerce.

All of which is to say that investors and advisers shedding a tear for the demise of Aviva’s fund need not feel too miserable, given the attractive alternatives available in the investment companies sector. Equally, even if regulators do not seek to kill off open-ended funds, it increasingly looks as if market forces will do the job for them.