“We regard liquidity mismatches as a major structural flaw.”
Two Irish commercial real-estate mutual funds, with a combined value of around €1.4 billion, have blocked redemptions after sustaining heavy outflows, leaving thousands of investors twisting in the wind. This has stoked fears that the liquidity issues that have dogged the UK’s mutual fund industry over the past year, beginning with the high profile gating of the £3.7 billion Woodford Equity Income fund (WEI), have now spread to another European economy. According to U.S. ratings agency, Fitch, contagion is now a very real danger.
Both of the gated funds were “open ended,” meaning they offered investors daily liquidity. When large numbers of investors began taking advantage of this facility by taking their money out, the funds had to sell assets in the portfolio to raise enough money to meet the withdrawals. This is not a problem when the assets in question are highly liquid, such as large-cap stocks. But when the assets are commercial real estate that can take weeks or more likely months to sell, there is a mismatch in liquidity between what the fund offers to its investors (daily liquidity) and what the fund holds (largely illiquid assets).
This is a big risk with these types of open-end mutual funds. And that risk could be about to grow, warns Fitch:
We regard liquidity mismatches as a major structural flaw that is likely to become more evident if the European CRE sector, or investor sentiment towards it, weakens. There is also the risk of contagion. If a fund experiences a spate of outflows, investors in other funds invested in similar assets may move fast to redeem their holdings to limit exposure to declining asset values after forced sales. If a fund is gated, the publicity may increase this contagion effect, while also potentially causing wider reputational damage to the investment manager and the sector.
Ireland’s commercial real estate market has bounced back impressively from the last crisis. But concerns have been rising that the boom is running out of steam, partly due to the mammoth troubles of WeWork, which, which after its scuttled IPO and subsequent write-down and bailout by SoftBank, pulled out of two big Dublin property deals in October. Since then, a number of property funds – including funds managed by Irish Life, Zurich Life Assurance and Aviva – have cut the value of their portfolios after being hit by a surge in redemptions.
But even that wasn’t enough. Last week, the Irish Property Fund and Friends First Irish Commercial Property Fund, both owned by the British insurer Aviva, announced they were freezing withdrawals for up to six months after failing to meet investors’ demands for the return of their cash. The funds, whose properties include the Royal Hibernian Way shopping mall in Dublin and the Globe Retail Park in Naas, have already been marked down by 7% and 9.1%, respectively.
Contagion already appears to be spreading across parts of the UK fund industry following the gating last year of WEI and M&G Property Portfolio. Once worth £10 billion, WEI was closed for good in October, leaving more than 300,000 (largely retail) investors shouldering losses of up to 50% of their initial funds. As for M&G Property Portfolio, it closed its doors in December after investors yanked an estimated £900 million from the fund in the first ten months of 2019. The fund remains shut today as it tries to raise cash by selling some of its assets.
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