Unlocking property

Some good news at last for investors in open-ended property funds. In the Spring and early Summer, dealing in these funds was suspended, locking investors in after the Covid-19 pandemic had sent stock markets tumbling and prompted a run for the exit doors across the sector. But in recent weeks, almost all these funds have announced they are reopening to withdrawals; most should be ready to do so by the middle of next month.

Crisis over, then? Well yes, but only to an extent – and only for the time being. The first point to make is that in most cases, these funds have had to sell assets and build up their cash positions to be confident they will be able to meet the demands of investors who want to get out once this is possible again.

And second, what happens next time a crisis of confidence hits the markets? The Financial Conduct Authority (FCA) is now finalising new regulations to govern these situations, but there is no getting away from the reality of the open-ended structure: when lots of investors rush to sell their holdings, fund managers are forced to quickly sell assets to repay them; this may lead to fire sales or simply prove impossible. The imposition of suspensions is a familiar outcome of market crises, last seen following the Brexit vote in 2016.

Savvy advisers recognised the solution here long ago. One reason for the increased popularity of investment companies in recent years lies in the attractions of their structure when it comes to holding illiquid assets such as property. A closed-ended fund provides daily dealing for investors even when there is the most severe crunch in the asset class in which it invests.

This is not some sort of clever magic trick. It simply reflects the fact that investment companies are listed companies with a fixed pool of assets; those assets will rise or fall in value over time, but shareholders get in or out of the fund by buying or selling their shares on the open market, not by putting money into the portfolio itself or taking it out.

This is not to suggest investment companies are immune from market disruption. Shares in many closed-ended property funds have fallen sharply this year – and often by more than the value of the underlying portfolio, with a number of investment companies in the sector currently trading at a substantial discount to net asset value.

But that is not the point here. Investors who want out of these funds have been able to sell their shares at any time during the crisis of the past six months – investment companies remained open every single day that open-ended funds were closed to withdrawals. Moreover, when investors have crystallised their losses, they have done so without undermining the prospects of those sticking with the funds for the longer term, since managers have not had to sell assets to pay up.

This whole story has been yet another reminder of the compelling case for using investment companies rather than open-ended funds to invest in illiquid assets. The FCA clearly thinks so too – although it has stopped short of saying so outright, it has mulled reforms that would make it very difficult to hold open-ended property funds inside an individual savings account, which sends a pretty strong signal.

The question now is whether advisers and investors have learned the lesson. The FCA isn’t going to put open-ended property funds out of business, but if we don’t see a steady reallocation of cash into the investment company sector over the months and years ahead, it will be difficult to understand why not.